At the end of last year, FreightWaves described 2019 as a winless season for the trucking industry. Looking ahead to 2020, there appears to be widespread optimism among carriers and analysts that this year could be better than last, particularly in the second half, following an exit of capacity as a result of higher insurance costs and stricter drug and alcohol regulations, among other factors. Whether that scenario comes to fruition remains to be seen, but few seem to expect two winless seasons for the trucking industry in a row.
Looking ahead to writing a similar piece at the end of 2020, which sectors of transportation this year might resemble the 2008 Detroit Lions or the 2017 Cleveland Browns? One candidate is railroad equipment manufacturing. This follows the mid-single-digit railroad volume decline last year combined with railroads using existing equipment more efficiently while cutting their budgets for capital expenditures. Another candidate is truck equipment manufacturing and sales, given that we consider trucking equipment to have fundamentals that lag those of the trucking carriers. So, one winless season begets another.
I write below about the challenges facing the truck equipment industry in 2020, but concede the year won’t be winless since it has already had one major win — Navistar shareholders. Navistar shares are up 28% year-to-date following the unsolicited bid by TRATON (the Volkswagen truck equipment subsidiary) to acquire the remaining shares.
Weak used truck prices are an albatross on further new equipment purchases
New equipment prices typically inflate as there are changes in requirements to meet stricter environmental standards, but in years absent of major changes to fuel efficiency or emissions standards, equipment prices generally rise moderately amid market share competition among the four original equipment manufacturers, or OEMs. The bigger swing in year-to-year pricing from the perspective of the buyer comes in the form of the price, net of the associated equipment that is being traded in; the large majority of new truck purchases come with an associated trade-in.
SONAR data for 5-year-old used trucks (the age associated with the greatest number of initial trade-ins) shows they are about $10,000 below the average since the beginning of 2013 and are currently at the lowest level since early 2011. Put another way, 5-year-old used Class 8 tractor prices are about $20,000 below the historically high prices of 2014, when there was a lack of “good used” equipment that resulted from a lack of building during and immediately after the Great Recession.
Used truck prices are 22% below average since 2013 and 37% below their high
Historically low used truck prices are likely to persist
There is evidence to suggest that used truck prices are stabilizing at a low level: SONAR used-truck data is off its low; and comments from PACCAR’s management suggest that the volume of equipment entering the used truck market is roughly equivalent to the volume of equipment being sold, and thus exiting, the used truck market.
While that is somewhat encouraging, there are still two factors at play that are likely to keep used truck prices depressed. First, Class 8 production in both 2014 and 2015 were at historically high levels of 297,000 and 323,000 units, respectively, well ahead of the North American replacement rate, which we have seen estimated at between 220,000 and 275,000 units.
Trucks are generally traded in by the first owner after four to six years with the fifth year being the most common for a trade-in. Therefore, a large portion of the near-record 2015 production will be coming into the used truck marketplace this year. Secondly, I believe that the large leasing companies are holding onto equipment longer than they normally would in order to avoid selling at low prices. (Navistar described this on its last earnings call.) Therefore, even if we see appreciation in used truck prices, those higher prices would likely encourage the major leasing fleets to sell more used equipment, adding to supply and putting downward pressure on prices.
The Class 8 market is oversupplied because of historically high production levels in four of the past six years
During the six-year period from 2014-2019, Class 8 tractor production averaged 295,000 units with production higher than replacement rates first during 2014 and 2015 and again in 2018 and 2019. The heightened levels of demand were not only driven by high spot rates at times during that period, but also by carriers chasing the improved fuel economy and reliability of the later-model-year tractors. Therefore, even if one uses an aggressive estimate for Class 8 replacement rate, that still equates to excess production of 120,000 units during the past six years, and results in a much higher excess for those who believe that the 275,000-unit replacement rate is aggressive. In addition to the equipment excesses, the volume of deliveries the past few years has reduced the average age of equipment in the field, which gives the larger fleets more leeway to delay further equipment purchases. Those factors, combined with an inflated Class 8 manufacturing backlog of 297,000 units at the beginning of 2019, caused 2019 Class 8 orders to be the lowest of the decade.
2019 orders were below recent years; backlog fell from 297,000 to 123,000 last year
Fundamentals in the truck equipment industry typically lag carriers’ fundamentals
FreightWaves has described Class 8 truck manufacturing as a lagging, cyclical and seasonal indicator of demand. The SONAR chart above illustrates that phenomenon, showing that Class 8 orders typically improve two to six months after a spike in truckload spot rates, with that lag varying seasonally. The reason is straightforward — improvement in truck spot rates typically lead to a surge of equipment orders. Why? Carriers attempt to take greater advantage of the strong rates and expanding margins with a larger fleet of trucks to carry more volume.
That historical pattern, combined with the expectation that the trucking industry fundamentals are not likely to improve in earnest until later this year, suggests that Class 8 orders may not improve until the traditional order season (October through the first quarter). While fourth-quarter orders, or the anticipation thereof, may help the equipment companies’ share prices, those orders may come too late in the year to cause much of a pickup in 2020 volumes. This is because fourth-quarter truck orders are mainly for equipment with delivery dates in the next year.
That leaves 2020 with production volume sharply below 2019 levels, even if the truck market improves later in the year, as many expect. Accordingly, the public companies that have provided guidance on outlook for North American heavy-duty truck production are averaging a 30% year-over-year decline.
Spot rates lead truck orders; rates are not strong enough to encourage high order levels
OEMs/suppliers expect their heavy-duty markets to decline 30%, on average
The anticipated improvement in the trucking market is supply-driven; manufacturers would be helped more if it were demand-driven
While many seem to expect supply-driven improvement in trucking fundamentals, few expect an improvement to be demand-driven. Similar to what FreightWaves has reported regarding the Celadon bankruptcy, much of the equipment and many of the drivers from defunct carriers will find their way to other carriers. The largest and best capitalized fleets tend to be new truck buyers, so a strong truck market should certainly encourage purchases by that segment. However, carrier failures could be one more factor that puts downward pressure on used truck prices, discouraging new truck purchases by carriers that are buyers in both markets.