FREIGHTWAVES' SONAR CHART OF THE WEEK (AUG. 05, 2018- AUG. 11, 2018)
Chart of the Week: (SONAR: DATVF.LAXDAL) DAT Van Truckload Spot Index for the Los Angeles to Dallas Lane.
SULTAN OF SONAR SAYS:
Wall Street trashed the stocks of the large asset truckload carriers on the back of record earnings and high performance among nearly every carrier. Werner (NASDAQ:WERN) was the first major truckload carrier to report, trouncing analyst consensus by over 11 cts per share. This 18% out performance was rewarded with a massive sell-off of the entire sector. This only reinforces the view by many truckers that most people love to hate the trucking industry: do bad, you will be punished. Do great things and you will be punished.
Before Werner reported on July 23rd, truckload stocks were recovering from the sell-off from panicked traders over tariffs. As soon as trading opened on the 24th, the sell off began. The worst performer of the pack this earnings season was Knight-Swift (NYSE: KNX). The newly merged company of Knight and Swift missed by a penny, resulting in a sell off of more than 15% since the third week of July. Universal Holdings (NYSE: ULH) and Pam Transport (NASDAQ: PTSI) have not been caught up in the selling. Universal Holdings saw the price of it's stock increase by nearly 25% and Pam is up 21% in the same period. All of the other truckload carriers are flat or down since July 23, 2018.
The view that traders took was too much of a good thing, is a bad thing. The thesis is that carriers reported the best earnings in their history, and because the metrics were so strong, it will create a run-up in capacity entering the market, eroding pricing power for carriers.
This cycle of boom and bust has played out before and investors think history will repeat. While one could suggest that Werner's earnings set the market into flames, we believe something else prompted the emotional reaction of traders in the market.
On July 24, Truckstop.com's Chief Economist, Noel Perry, sent out a memo suggesting that the market was about to turn. In his view, the trucking market has reached it's peak and we are bound to repeat the freight recession of 2015/16.
While we have a lot of respect for Noel's views, he is not doing a service to traders and truckload carriers by playing Chicken Little, especially when referencing data that is derived from the subprime part of the market, a portion that the public truckload carriers have very little exposure to. There is little data presented in the note, which makes it that much more disappointing.
Traders would be wise to exercise caution when using Noel's note on July 24th as a baseline to understand the freight markets. Unfortunately, Truckstop's spot index feeds data into Bloomberg, giving Wall Street traders a view of the trucking market from the Truckstop data-stream. No matter how uncorrelated the two markets are (Truckstop's and the large asset-based carriers), traders that are starving for information use it as their reference to make their decisions on the health of the trucking market.
Noel's newsletter is timed on the same exact date as the massive self-off the truckload sector. Any positive conclusions one would draw from Werner's report that was released on the 23rd were overshadowed by Noel's note. The market is still struggling, indicating that traders are still concerned about these macro trends. The only data that Noel referenced in his analysis was Truckstop's own spot-market data.
While this may not represent the entirety of the dataset Noel used to draw conclusions (we can appreciate dumbing things down for most readers), Truckstop.com's spot market data is not a great barometer to draw conclusions about the market that the large carriers participate in.
Our reasons for stating this are three-fold: the sample size of rate data is relatively small, the index allows quoted loads (not actually hauled loads), and the sources of data are down-stream in the subprime market.
First off, size.
According to sources, Truckstop.com collects transaction spot data worth about $10B of the freight market. To put this in perspective, this is approximately the same size of CH Robinson's purchased transportation budget and less than 5% of the entire U.S. for-hire truckload market. Truckstop has recently partnered with Chainalytics to increase the size of their data by pulling in Chain's much larger dataset, but we do not believe that Noel is using any of Chain's data in his analysis.
Second, quoted loads.
We understand from sources familiar with the way Truckstop build's their index they allow for quoted loads to be included in the index calculations. Quoted loads are pricing inquiries and postings that are added to Truckstop.com's load board by brokers to inform the carriers what the broker is willing to pay for a load. This pricing data is essentially crowd-sourced and non-binding, based almost entirely based on sentiment, with no reference to what the loads actually end up be hauled for.
Third, the data that Truckstop gets is from the "subprime" part of the market.
Truckstop has built a successful business and plays an important role in the freight markets. For many small carriers and brokers they provide a great toolset to enable them to run a small business. Their TMS, load-board, factoring services, insurance offerings, tracking, and payment services are wonderful resources for small brokers and carriers that want to be their own boss. They play an important role in the market and we are cheering them on to build out more products that make the lives of small players easier and more successful.
Truckstop takes in data from the same audience of small brokers and carriers to build their index. This is in an entirely different portion of the freight market than the large asset-based truckload carriers play in. Even what freight they take off the spot market, it's usually the premium priced spot freight (last minute expedited/surge) or on a limited basis to reposition a truck out of a soft market (Montana for instance). Large public carriers have deep customer relationships and are not sourcing freight off of load boards.
If you are building your index based on load-board quoted rates, you are going to struggle reflecting direction in the public truckload portion of the market. Even if the freight market is softening, the largest carriers in the market will be the last to be impacted. Carriers that rely on Truckstop for loads are typically small and far greater exposed to market direction and whims.
DAT is also a load board company (much larger than Truckstop), but they derive their index from load tender data in the market, not off load board quotes. They get data feeds from large enterprise brokers, carriers, and shippers in the market, giving them a record of actual loads that were hauled in the market. This index is created from actual load tenders, representing $54B of truckload transactions in the market. Their data feeds include most of the large freight brokers in the market.
For the large listed carriers, the DAT spot index is more relevant to their portion of the market. Large carriers typically stay away from transactional voice brokers, but are comfortable in taking freight from the large enterprise 3PLs (the same ones that feed data into DAT's index). Large public truckload carriers maintain a portfolio approach to shipping clients: Dedicated, contract (committed), and spot make up the freight volume. The largest (the public guys) keep around 10-15% of their capacity in the spot market. If the spot market softens, they will feel little pressure on their business, unless the spot market completely collapses like it did in 2015.
So what does DAT's index tell us?
Spot rates are still at record highs, even in one of the slowest times of the year. One of the most volatile lanes in the market is the Los Angeles to Dallas lane. It is also one of the lanes that is most exposed to changes in trade flows from the ports.
Over the past twelve months, the DAT spot lanes are showing rapid inflation and have sustained record levels. The Los Angeles to Dallas lane, one of the largest freight corridors in the country is at $1.87 a mile, up $.40 a mile from this time last year. It pulled back from $2.27 a mile a few weeks ago after experiencing an unprecidented second quarter surge. Even since the start of the second quarter, the lane has appreciated by $.37/mile (it was at $1.50 on April 3rd).
Put into historical perspectives, the chart is even more impressive.
Going back to 2014 (the peak of the last freight cycle) the highest number posted in July was $1.61. This July 2018, the highest posted rate was $2.09. The smallest number in July 2014 was $1.37/mile, in 2018 it was $1.83/mile. Backing out the inflation in driver wages (fuel surcharge is taken out of the numbers), the net increase to operating profits should be around $.25-40/mile for loads on this lane. This results in nearly 20% of the load going towards contribution margins, most of which flow into the profits of the carriers.
The other interesting data point is to look at last July from a historical perspective. The freight market always pull back until late summer. In June 2017, the LA to Dallas lane peaked at $1.66 a mile (up from $1.29 to start the 2nd quarter). It then dropped back to a 2nd half low of $1.34 on August 21, 2017. This 19% drop was followed by a bang up rally that peaked on November 12, 2017 at $2.38/mile (a 75% surge from the August low).
Since the start of Q3 2018, we have dropped back 21% on the Los Angeles to Dallas lane, a similar drop to what we saw last year. If we are near the bottom of the chart on this lane, we could see an amazing rally to end the year.
Why are traders concerned?
The downside, of course, is that the great operating dynamics of the market encourage carriers to add capacity. This is true and shouldn't be discounted. Every boom cycle eventually ends as capacity outstrips demand. But the reality is that the large carriers are not adding capacity at a rapid clip to handle demand.
Large enterprise carriers typically grow their capacity by adding drivers that are employees, rather than independents. Trucking employment is certainly up since the start of the year, starting the year at 1.459 million. In July, the BLS reported that the adjusted number of trucking employment is at 1.480 million. This 21k increase suggest that carriers are having some success in seating trucks, even when it is incredibly difficult. Looking back to July 2014, employment dedicated to trucking was clipping at 1.419 million. This means that over four years, the industry has only added 4% more in total employment. Even if 100% of this growth were in truck drivers (it's not), it wouldn't be enough to handle the shipment volume growth during the same period.
Volume of shipments have increased 8.8% since July 2014 according to the Cass Freight Index.
The argument that has some merit, but not discussed by larger carrier executives, is the growth of the small and independent truckers. After all, truck orders are at an all-time record high (52,400 in July), up 180% over July 2017. These trucks must be going somewhere, right?
Backing in demand coming from carriers expanding dedicated fleet operations in response to shipper efforts to secure capacity, the numbers suggest a strengthening market for small operators.
Small owner-operators are the largest buyers of used trucks in the market. They will buy trucks from the larger enterprise carriers when they have completed their cycles. Three years usually marks the starting point for when large carriers turn in their trucks to the secondary market. In looking at the used truck sales data on a 3 year rolling age, we can see if the market for such trucks is increasing or falling back.
According to the 3 Year Old Used Truck Price Index, 3 year old trucks are going for $62,654. They were at $76,689 back in July 2014. This suggests that the used truck market is not nearly as hot as it was a few years back. The reason for the hot demand on new trucks could be an indication of increasing confidence of large enterprise carriers in their ability to add drivers with recruiting programs and the attraction of the newer trucks that get far better fuel economy (7.5-8 mpg. vs. 6). The other element is that newer trucks have fewer maintenance issues and carriers like to purchase the trucks when the market conditions are good.
The used truck market does not suggest we are at risk of being oversupplied from small operators.
The last reason that no one should panic is related to demand and the broader economy. The reason the freight market fell apart in 2015 is not related to over supply of trucks, but a fall out in demand. Commodities peaked in the summer of 2014, with oil prices beginning an 18 month descent into one of the steepest oil crashes in recent memory. The price for West Texas Intermediate crude oil in the summer peaked at $107.26 on June 20, 2014. By January 2, 2015, the price of WTI was trading at $52.69. It continued down to $26.55 on January 20, 2016.
The cause of this is largely related to the oil markets being shocked by how fast U.S. domestic oil production came online with the US flooding the market with crude. It also effectively broke the pricing power OPEC over the global energy markets.
What was little understood at the time, was how much the oil markets were driving the U.S. freight market. Historically, as oil prices went up, it created a drag on earnings of the truckload carriers because diesel prices were a direct expense. In theory, higher diesel prices would be a headwind on carrier earnings. With oil prices dropping, so would diesel prices. When 2014 started, diesel prices were at $4.00/gallon, dropping to $1.97 in January 2016. The drop in diesel prices coincided with the drop in crude prices.
In theory, lower oil prices should be great for carriers because their costs of diesel would be lower. But most truckload fleets have little, if any, exposure to diesel price volatility. The price of diesel is passed on to shippers in the form of fuel-surcharges, allowing them to recoup their costs. In the universe of truckload data that we track, net fuel expenses are around 5% of revenue for all mid-sized carriers. The largest fleets (especially the public ones) have better buying power for fuel, more fuel-efficient trucks, incentive programs for drivers, and better shipper contracts, fuel can actually be cost neutral. With this being the case, carriers should not be concerned about higher fuel costs dragging down earnings and if higher oil prices result in more freight demand and economic expansion, then trucking board rooms are long oil.
As Sam Tibbs, FreightWaves' own oil economist likes to remind us, for every fracking rig created in the U.S., it adds 1.1 million truckload miles to the market. As oil production increases, so does demand for trucking services in/out of oil wells. Commodities such as metals and sand are used to extract the oil from horizontal wells.
Oil also pumps lot of money into the domestic economy that flows into other sectors. This multiplier effect creates consumer and manufacturing demand, driving other sectors of the freight economy. For truckers, high oil prices are truly black gold.
Another factor in the oil markets that are also driving the domestic freight economy is the relative discount that U.S. oil has versus the global market. This reference for this difference is presented in the delta in prices of Brent Sweet Crude and West Texas Intermediate. Brent is the benchmark index for global oil prices, while West Texas Intermediate (WTI) is the price for oil pumped in the U.S. As the gap between the global price (Brent) and the U.S. price (WTI) widens, it creates more demand for U.S. crude and fracking.
Throughout much of the freight recession, the spread was pretty flat. Through the second half of 2015 till the second half of 2017, the spread stayed below $3/barrel. The changed around summer of 2017, coinciding with the violent swing in trucking spot rates.
Right now, the spread is around $3.80. On June 19, 2018, the spread got as high as $9.83, only to be interrupted by a plea from Donald Trump to the Saudis to lower their pressure on the global price of crude.
The conclusion we can draw from all of this is that there are no signs that a freight recession is imminent. The last freight recession in 2015 was caused by a lack of industrial demand and the softness in the oil markets. If the oil markets stay strong (and they appear to be strengthening), this will drive many parts of the industrial sector. Combine this with other parts of the economy that seem to be firing on all cylinders and you get a strong freight market.
Wall Street should relax. Carriers will continue to put up great numbers in 2018.
Disclosure: members of the FreightWaves team that contributed to this article own positions in some of the publically-held truckload carriers.
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About Chart of the Week
The FreightWaves Chart of the Week is a chart selection from SONAR that provides an interesting data point to describe the state of the freight markets. A chart is chosen from thousands of potential charts on SONAR to help participants visualize the freight market in real-time. Each week the Sultan of SONAR will post a chart, along with commentary live on the front-page. After that, the Chart of the Week will be archived on FreightWaves.com for future reference.
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