Rail, Trucks And Parcel Expected To Grow As GDP Rises And Capacity Declines; CSA Regulations Curtails Available Driver Population Further

Wall Street Transcript

67 WALL STREET, New York - December 20, 2011 - The Wall Street Transcript has just published its Transportation and Logistics Report offering a timely review of the sector to serious investors and industry executives. This Transportation and Logistics report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: FMCSA CSA Regulations - Capacity Constraints Result in Pricing Power - Truckload, LTL, Parcel, Rail and Intermodal - Retail and Industrial Transportation Demand

Companies include: C.H. Robinson (CHRW); CP Rail (CP); CSX (CSX); Expeditors (EXPD); Hub Group (HUBG); J.B. Hunt (JBHT); Kansas City Southern (KSU); Kirby Corporation (KEX); Knight Transportation (KNX); Old Dominion Freight Line (ODFL); Pacer (PACR); Roadrunner (RRTS); StealthGas (GASS); Swift (SWFT); Union Pacific (UNP); Werner Enterprises (WERN) and many more.

In the following brief excerpt from the Transportation and Logistics report, analysts discuss the outlook for the sector and for investors.

Christian Wetherbee is a Senior Analyst in the industrials group at Citi Investment Research & Analysis covering airfreight, surface and marine transportation. He has more than 12 years of Wall Street experience, including six years covering the transportation sector. Before joining Citi in 2010, Mr. Wetherbee was the Senior Transportation Analyst at FBR Capital Markets & Co., which he joined after 10 years at Merrill Lynch holding numerous positions, including the past five as a Publishing Analyst on the Bank of America/Merrill Lynch equity research team. Mr. Wetherbee received his B.A. from the University of Maryland and completed his MBA in finance and accounting with honors at the Fordham University Graduate School of Business.

TWST: You mentioned the pricing dynamics. Would you expand on that?

Mr. Wetherbee: Sure. I think the first one, the most obvious subsector in terms of the pricing dynamic, is on the railroad side. Since 2004, the railroads have been enjoying a very strong secular push on core pricing in their industry. We have seen quite a bit of an evolution of the rail industry since it was deregulated in 1980. You went through a decade or two of significant consolidation, which ultimately rationalized a lot of capacity in the railroad space in the 1980s and 1990s. Then in the 2000s, we had China entering the WTO, and you had a stretching of supply chains, which added quite a bit of intermodal traffic to the industry.

The combination of all of those factors basically has led to a scenario that in the mid-2000s, a few years out of the last economic recession, you ended up having demand fill existing capacity. When that hit, the rails got pricing power. They started to push up pricing and margins started to improve, and you have a consolidated space with, in the U.S., four major competitors. There are five rail companies in the U.S., plus the two Canadians, so there are seven Class I railroads in total in North America. But geographically, the competition is somewhat limited. That means that in many cases, you only have one major geographic competitor, meaning that there are two companies generally in each region. That has made for a rational and very effective pricing really ever since 2004 and including 2009, when volumes were down in the rail industry in the midteens. So they were actually priced up 5% in 2009, when volumes are down 16%, 17%.

TWST: What about in the trucking space? What is happening there?

Mr. Wetherbee: Truck is a little bit different than rail. We talked a little bit about freight, and as I mentioned, freight tends to be early cycle, so goods start to move before the economy really picks up. And because it is early cycle, goods in the freight transportation tend to trail off before the overall economy starts to show signs of weakening. And we did see that going into the last recession. So about halfway through the fourth quarter of 2006, we started to see truck and rail volumes deteriorate and turn negative and they were negative for all of 2007, all of 2008 and obviously 2009, when the economy got really bad.

However, you had a scenario in the truck space, following several years of very strong volumes and pricing, where there were quite a few tractors built up, so the U.S. fleet was fairly robust in 2006. Factors like regulation changes on emission standards for the tractors caused companies and drivers to prebuy tractors, plus they were feeling flush from several good years of operating profit. All that means there were a lot of tractors in 2006. Then you had the market turn away from you beginning in 2007, and it persisted all the way through 2009, so you ended up seeing capacity rationalization from the peak in 2006 for the last four years. We are now entering the fifth year of capacity rationalization within truck, and what that has finally gotten to is a position of more balanced supply and demand. This year, while the demand side was fairly modest, it was slightly positive. That said, the market is tight enough that the truckers were able to produce about 4% core pricing gains on the back of 1% or 2% volume gains. And so another situation with scarceness of capacity and that's likely to persist next year. Truckers have been ordering tractors, but largely for replacement as opposed to incremental additions to their fleets. As a result, in the order of magnitude that we've been seeing, which is about 4% excluding any impact for fuel surcharges.

TWST: Do you expect that these current trends will continue or are there major changes on the horizon?

Mr. Wetherbee: I think from a volume perspective, our view here at Citi is for the U.S. economy to grow just below 2% next year. That's the basic assumption that we are working with, so we expect to see a very similar GDP growth environment next year to what we had this year. That may not be great, but it is certainly better than flat or negative growth. It's enough to keep revenues moving in the right direction for these freight companies, and as I said before, if you couple that with positive pricing dynamics - which we have with truckers, with railroads, with the package guys - then you are likely to continue to generate arguably slightly better margins depending on what happens from a cost perspective and EPS growth at the end of the day, which is not going to be all that dissimilar from the rates that we had this year.

The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This Transportation and Logistics report is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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