In trucking, gains and losses on asset sales typically center on the sale of revenue equipment like tractors and trailers, and to a lesser degree real estate. The gains booked on the disposal of assets can provide meaningful swings in quarterly earnings, sometimes determining whether a company beats or misses expectations.
The replacement of tractors and trailers is an ongoing event at most large fleets. Carriers look to replace equipment on a regular schedule, prior to the age when maintenance and repair costs escalate and fuel economy deteriorates. Also, drivers like operating new tractors, which have the latest technology and safety equipment. This is a selling point for fleets in the recruitment and retention of drivers as most of the large, well-capitalized truckload carriers have an average equipment age of 2 years or less.
The ongoing replacement of first-generation equipment into a highly fragmented TL market, in which most carriers aren’t able to take advantage of economies of scale and attractive lending terms, creates a large secondary market that is looking for well-maintained, secondhand trucks. This provides a support level for trade-in values, allowing carriers to book gains in most markets.
Gains on sale usually appear on the income statement as a reduction in expenses on the “other operating expenses” or “miscellaneous operating expenses” lines. It can show up on its own line as well. In any case, the entry usually nets out sales-related expenses, or the cost to prep the equipment for sale.
Replacement activity by the large, publicly traded carriers is viewed as part of the normal course of business, meaning the impact to earnings is included by analysts in their consideration of a company’s future earnings power and valuation metrics. Gains — or losses — on the sale of equipment are actual financial events, likely to recur, thus their inclusion when considering future forecasts. However, analysts will normalize outsize gains to historical averages if they are unlikely to continue at the same magnitude.
While gains on the sale of revenue equipment are viewed as core items, analysts often back out gains realized in the sale of real estate, as they are typically nonrecurring or one-off items and are sometimes part of a larger network downsizing.
Gains on sale can impact a quarter by several million dollars at some fleets. The numbers can account for a few percentage points in earnings and upwards of 20% for some operators.
Used equipment prices move gains on sale
The amount of the gain is impacted by demand in the used equipment markets.
Following a robust 2018 freight demand environment that saw record truck buying, freight demand tanked in 2019 as did the need for trucks. This resulted in a material step down in trade-in values by the fourth quarter of 2019, which carried through the first half of 2020. Thus, gains on sale fell and turned negative for some carriers.
It’s not just overall freight demand and truck buying activity that determine resale value. The ability of medium and smaller fleets to access credit at accommodative interest rates weighs into equipment demand as well. Banks often reel in lending programs when the freight market sours, thereby limiting risk exposure to the group.
In addition to the amount of the gains per unit sold, mix (tractors versus trailers), age and the number of units sold can swing the line item.
Knight-Swift Transportation (NYSE: KNX) sums up all of the factors affecting the line item in its annual filing with the Securities and Exchange Commission.
“We are sensitive to the used equipment market and fluctuations in prices and demand for tractors and trailers,” the risks section of the report reads. “The market for used equipment is affected by several factors, including the demand for freight, the supply of used equipment, the availability of financing, the presence of buyers for export to foreign countries, and commodity prices for scrap metal. Declines in demand for the used equipment we sell could result in diminished sales volumes or lower used equipment sales prices, either of which could negatively affect our gains on sales of assets.”
In declining markets, some fleets hold off on trades or lower the number of units they sell, waiting for a better time to unload equipment. But the decision not to sell equipment may be seen on other expense lines like maintenance and fuel, and in driver satisfaction, if the average equipment age creeps too high.
Importantly, most large fleets have their equipment trades locked in through fixed-price agreements with OEMs, which can limit some of the volatility.
A material decline in used values could also require companies to record impairments to the carrying value of equipment if the declines are drastic. Although not a carrier, truck lessor Ryder System (NYSE: R) recorded a depreciation charge related to the markdown of residual values across its fleet in 2019. That resulted in a net loss for the year.
Losses on equipment disposals and asset write-downs are not part of the current environment. Freight demand is robust, truck demand remains elevated and many fleets are struggling to procure production slots with the OEMs to facilitate normal replacement schedules. Shortages of labor as well as semiconductors and other parts are all part of the headwinds to truck production currently. Used values have soared and carriers are booking large gains on sale again.