U.S. Heavy Truck Orders Rise for First Time in Nearly Two Years

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The Wall Street Journal  /  December 5, 2016

November upturn signals truck manufacturing decline has bottomed out, but outlook remains tepid

Orders for heavy-duty trucks rose in November from the same month in 2015, the first such increase in nearly two years, in a sign that trucking companies see the freight market bottoming out.

Industry research firm FTR Transportation Intelligence said in a preliminary report that fleet owners ordered 19,300 vehicles in November, up 18% from a year earlier and 41% from the previous month.

Other analysts estimated orders were up 16% year-over-year last month.

The bump follows 20 consecutive months of decline in orders for Class 8 trucks, the big rigs that carry goods on long-haul routes, as fleet owners cut back plans to expand or replace vehicles amid weak shipping demand.

However, orders remain below-normal for this time of year, usually the peak period for buying new heavy-duty trucks. In October—a time when fleets typically set plans for the coming year—order cancellations reached the highest rate in more than 20 years.

There are “too many trucks chasing too little freight,” said one analyst. “We’ve had no freight growth to speak of in the last six quarters.”

Analysts predict Class 8 truck production will total roughly 202,000 vehicles in 2017, a decline of about 12% from this year.

Equipment makers have laid off thousands of workers and reduced output from their North American factories over the past year as orders have declined.

Daimler AG, which sells trucks in the U.S. under the Freightliner and Western Star brands, and Paccar Inc.’s Kenworth and Peterbilt, are the country’s biggest Class 8 vehicle manufacturers.

Between the weak market and holiday shutdowns at truck factories, “we’re expecting November production to be weak and the December production to be pretty bad,” said FTR’s Don Ake.

The backlog of heavy trucks ordered but not yet built is expected to increase in those months.

Analysts with Stifel Inc. said they expect a 13% decline in truck orders next year. The November upturn “should be viewed as in line with relatively low expectations, though perhaps encouraging that demand has not deteriorated any further,” the analysts said.

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November Class 8 Truck Orders Indicate Stabilized Market

Heavy Duty Trucking  /  December 5, 2016

There was a significant and expected increase in Class 8 truck order activity during the month of November, according to preliminary numbers from FTR.

Net orders are projected to hit 19,300 units for the month, representing a 41% increase in order activity compared to October. Backlogs are also expected to increase for the first time in 10 months.

“Class 8 orders came in right as expected in November.  It is good news that the market has stabilized and is following seasonal trends,” said Don Ake, vice president of commercial vehicles at FTR.  “Backlogs should increase in November and December as production dips, however, this order level should allow production to bounce back some in Q1.”

Class 8 order activity for the past 12 months annualizes to 191,000 units, according to FTR.

“The downturn in the Class 8 market was in response to weak manufacturing and lackluster freight growth in 2016,” said Ake. “It appears business inventories have finally dropped and manufacturing is regaining strength. This trend is important for the Class 8 market to regain footing early in 2017.”

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Class 8 market dip in '17, with upbeat outlook farther out

Fleet Owner  /  December 5, 2016

With many speculating what the incoming Trump Administration will mean for trucking, those are really more 2018 considerations, say truck industry analysts. For 2018 though, analysts expect just over 200,000 Class 8 trucks will be built for the North American market.

"We've just got too many trucks and not enough freight," one analyst said. This year should close out at about 228,000 Class 8 trucks built before a continued downward trajectory into 2017. But several factors are likely to help the market pick back up starting in 2018, when ACT expects that 243,000 Class 8 trucks will be built.

And things could be on the road to much better after that, should a number of elements fall into place. "If everything goes according to the script that I have written, the conditions should be in place for a very nice Class 8 market in 2019 and 2020," he said.

New administration

Possible beneficial economic moves from the Trump Administration like pushing for tax cuts or infrastructure investments would come no sooner than 2017, and the fruits of any changes wouldn't be seen until 2018 and going forward.

"We've got at least two years to find out what total Republican dominance does to policy, just as we did in 2009 and 2010 when the Democrats had the same opportunity," he explained, noting Republican control of the presidency and Congress. That control "should mean free policy rein, and I do recall the Barack Obama quote from 2009 that 'elections have consequences,'" he added.

With the Trump Administration, some things to watch will be stances on trade, foreign policy and immigration, and then there is the 3 a.m. tweet thing, which I think makes us all a little bit nervous.

The North American Class 8 market was considerably weaker during the first 10 months of 2016 vs. the same time the prior year. The United States, which accounts for 81% of the market, saw a year-over-year Class 8 decline in that time of 47%. Canada, which is 9% of the market, saw a 26% decline in Class 8.

But one bright spot for Class 8 was Mexico, which represents about 8% of the North American market. Mexico has seen growth of 25% for the first 10 months of the year compared with the same 2015 period. Ultimately, it's still a 25,000-unit market, so what happens there only ripples so far.

Still, if there's a question regarding the future Trump Administration's policies, Mexico is a key consideration.

The thinking generally is that the new administration will ease up on regulations, which should be a boon for businesses: Whether it's labor, environmental or safety, those had been increasing headwinds for business and are likely to be mitigated.

Even if the new administration ultimately lightens the regulatory burden, don’t expect GHG Phase II requirements to evaporate. "I think the paybacks are so good on aerodynamics and parasitic drag that even if the Greenhouse Gas Phase II rules get rolled back, the vast majority of that mandate is going to happen because of the bang for the buck for fuel economy relative to cost," he said.

"I think the vast majority of the GHG Phase II proposal is almost 'baked in the cake,' regardless of what the Trump Administration does."

More positive 2018

The 2018 forecast for Class 8 is more favorable now that Donald Trump has been elected president. A theoretical President Hillary Clinton would've faced with a Republican-led House of Representatives and Senate, particularly with funding issues.

"Before the election, we were thinking of something like 225,000-230,000 [total Class 8 North American market units built for 2018] might've been a better place" than  our prediction of  243,000, he said. "That was kind of from the realization of having Hillary Clinton as president with the continuation of a Republican-led House of Representatives, which I don't think was ever in doubt.

"Then all of a sudden, if we try to push through a $500 billion infrastructure package, the House would say, 'Okay, but you have to cut $500 billion worth of spending.' So the aggregate level of spending was not going to change all that much."

President Trump should face smoother going in terms of working with Congress, but what will come of Republican legislative efforts is yet to be seen. If the rosier 2018 predictions are to come about, there will be indicators by about the third quarter of 2017.

"As we look back through history, I want to say that every up-cycle that we've seen in the marketplace has started in the fourth quarter," he said. "So if conditions aren't sufficiently good by the third quarter of 2017, you don't get bigger orders in the fourth quarter of 2017, which doesn't start production in time.

"So that's that 15,000-20,000-unit delta that we were contemplating."

A bubble popped

For Class 8, the present reality comes from a cyclical downturn that came on fairly dramatically. "From the end of 2014 to the end of 2015, we went from the top of a cycle to a rapidly deteriorating market heading into 2016, and it continued to deteriorate through most of the first half of 2016," he said.

That deterioration has stopped or at least slowed, he added, "but in short, in the current market, we've just got too many trucks and not enough freight."

How many too many trucks is that, exactly? Analyst’s fleet utilization model suggested there was about a 5% capacity shortfall at the end of 2014; today, the model shows the market is about 7% overcapacity. "From our model's perspective, that's about 105,000 more tractors than are currently needed in the marketplace," he said.

Precipitating the market declines for freight were dips in machinery and capital goods, where "you've got six-to-eight touches by a truck on a relative dollar basis." "Freight started going wrong when the commodity bubble popped in the second half of 2014," he said. "All of a sudden, all the commodity extractors — whether it was the oil guys, coal guys, steel guys, aluminum guys or farmers — they're all like, 'We're not making any money; we don't want any [new] machines.'"

Keeping in mind analyst’s approximately 100,000 excess truck estimate, productivity gains are also part of the Class 8 story. In 2013, truck tonnage in North America began a continuous climb while truckloads stayed relatively the same.

"Coming out of the recession, we've seen a lot of truck tonnage growth without a lot of loads growth," he said. "Where is it? Increased density? Increased utilization? A little bit of modal share? A little bit of online retail shift?

"Were we operating under the same conditions as we were during the last cycle, we would actually need about 10% more tractors — about 150,000 more tractors — than are currently on the road today to haul the same amount of freight," he continued. "So you can see the problem in a nutshell: especially in a slow-growth economy, high productivity growth leads to weak freight outcomes."

Points to note

Meanwhile, the U.S. has seen far less decline in the Class 8 vocational sector. "If you look at the U.S. numbers, we're not so bad in the vocational market," he said. "One of the reasons we don't have a 'hair on fire' bad forecast for 2017 is that the quarter of the market that is the vocational piece is holding up reasonably well."

Class 8 inventories are still swollen, but truck OEMs have adjusted production rates down accordingly. We've worked a lot of inventory off, but there's still a lot of inventory to work off.  

In terms of sales-to-production balance, trailers held up strong for about a year after the Class 8 tractor market began its decline, but they're now headed for their own equilibrium adjustment. "We saw trailer backlogs drop below 100,000 units in October, which was the first drop below 100,000 since early 2014," he noted.

"We still haven't adjusted production relative to the size of the backlog," he argued. "So we think there's certainly some production cuts coming up there."

Some signs on the economic horizon are looking up. In terms of strengths of lead indicators like commodity trends, stock market prices and consumer confidence, "over the last couple of months, it's generally been a better tempo on economic reports," he said.

Look for "generally slower growth" in the U.S. economy, with a pick-up likelier by around the mid-term elections. The economic recovery is at a tepid 2.1% growth in GDP and 2.1% growth in manufacturing, but there are encouraging signs regarding the latter.

"We're seeing some nice improvement on a worldwide basis in manufacturing," he said. "That's very good to see." He noted that Germany, the United Kingdom and India are seeing above trend growth in manufacturing, while China has moved to trend-type growth.

"In our argument of what's wrong with freight in the United States, it really gets back to commodity prices," he emphasized. "How you fix commodity prices is you fix aggregate demand for commodities globally.

"In the last few months, things are getting better globally," he said. 

Continued pressure on used

One area that's likely not to improve in the near future for Class 8 is the used market. And one thing to keep an eye on in this regard is contract freight rates vs. spot rates.

"I pay a lot of attention to the spread between contract and spot rates," he noted. "Contract rates have performed reasonably well compared to spot rates for the past 24 months," he added, while "the guys that operate in the spot market have just absolutely gotten killed over the last 22 months."

Trucking companies in the contract market tend to be new truck buyers, he explained, while those in the spot rate market tend to be used truck buyers. Monitoring used truck sales and extracting a small subset of 400,000-500,000-mi. trucks for a look at used sale performance, he noted that "through '14 and much of '15, there was a premium of $10,000 to maybe $12,000 above residual value or book value on equipment.

"A lot of fleets were actually booking profits on their used truck trades, and it encouraged them to do more used truck trades," he pointed out. "That flipped toward the end of 2015, and you can see that [used truck] average valuation in four of the last seven months has been below our estimated residual value. That becomes a real issue."

With trucks' residual values low, "several OEM groups" are holding back "some fairly large" used inventory stockpiles. "So there's a chunk of inventory that hasn't even been introduced into the marketplace."

All things considered, a rebound of used equipment prices doesn't look likely, and that will continue to put pressure on new sales. "For the near-term, there's probably more downward pressure on late-model used equipment values than upward," he noted.

ELDs' 'meaningful takeout'

A meaningful change in trucking is on the way with electronic logging devices, or ELDs, ACT believes. The group speculates that the coming ELD mandate is likely to squeeze perhaps significant capacity out of the market.

Midsize truckload carriers, which make up about 10% of the market, will lose about 5% of their numbers, or about 4,000 trucks. Small truckload carriers, which make up about 20% of the market, will lose a more substantial portion of their total at 10%, which amounts to 16,000 trucks.

Owner-operators will be most affected. Those make up 30% of the market, and they could lose 15% of their 240,000 total, or about 36,000 trucks. All accounted for, it’s estimated that the ELD fallout will amount to 56,000 trucks, which is 3.7% of total tract fleet capacity or 7.0% of for-hire fleet capacity.

"Basically, the big guys are running legal. It's when you get to the smaller end of the market and for-hire guys" where you'll find some paper log cheating, he said. Taking some midsize and small carriers out of the mix and accounting for them running excess miles, again, the total ELD "takeout" of Class 8 trucks will be the equivalent of 56,000 units.

"This is a pretty meaningful takeout," he said.

Shippers and insurers eventually could become a factor in fleets having ELDs, he contended.  "Now that it becomes a law, do shippers and insurers start to care about whether the brokered truckers they're hiring are compliant?" he pointed out. "At some point, this probably starts to matter."

Furthermore, "we do think that there are some post-mandate business failures that almost have to happen as guys just can't adjust to the new paradigm," he argued. "So this could be, especially for the big fleets, the gift that keeps on giving for a while."

Coming 'very nice' market

Analysts believe that the current buying/ replacement rates for tractors are on a cyclical schedule that will pick up as 2017 progresses and continue climbing from 2018 into much of 2020.

And around 2018, other market forces — including legislative activity the Trump Administration is likely to undertake — could make for some bright years for Class 8 in North America before the cycle falls off naturally in 2021.

"We do think there's a trade cycle. All of the trucks that were bought in 2012, '13, '14 and '15, as we look out to 2020, our [tractor] trade cycle model begins to ramp up pretty well," he said. "So if trucker profitability is in place then, there's likely to be a decent trade cycle as we look out to the end of the decade."

Pair that with the impact of ELDs, and the stage is set. "If the electronic logging device mandate delivers a fairly large capacity takeout at the same time as the Trump Administration delivers an infrastructure project, maybe a corporate tax giveback, and there's good freight volumes and more machinery being sold, yes, I  think there's a very good argument for a nice run-up in trucker profitability in 2018 and 2019," he told listeners.

"These guys will have a bunch of old trucks to replace that they purchased in 2014 and 2015," he noted. "If everything goes according to the script that I have written, the conditions should be in place for a very nice Class 8 market in 2019 and 2020."