Falling retail inventories, capacity corrections may soon benefit U.S. shipping and logistics sector

The end may soon arrive for a rare “inventory overhang” that has been an earnings drag on J.B. Hunt, ArcBest (ABF Freight), USA Truck and other national and regional trucking and logistics companies.

An investor note from Little Rock-based Stephens Inc. and an assessment by a national trucking economist suggest that retail inventories compared to sales are beginning to trend in the right direction.

When gas prices fell below $2 a gallon, many economists and retailers assumed consumer spending would tick higher, which resulted in retailers boosting inventories for the expected consumption rise. Also, the booming U.S. energy industry – which was fueling manufacturing growth – was keeping busy companies involved in national trucking, intermodal, logistics and other freight services. The trucking and shipping sectors were adding capacity to handle expected demand from consumer spending and the ongoing energy industry growth. But the consumers didn’t spend like they were supposed to. And the energy industry essentially entered a recession.

“But instead of following the playbook, most U.S. consumers have been choosing to pay down debt and increase their savings,” wrote Donald Broughton, a chief market strategist and senior transportation analyst with Avondale Partners, who provides economic analysis for the Cass Freight Index.

Broughton recently noted that high inventory levels have been a drag on the GDP for five consecutive quarters, and he predicted “de-stocking” would continue into the third quarter.

“This is the longest (high inventory drag) stretch outside of a recession since 1956-57 and the largest in magnitude since 1995,” Broughton noted.

American Trucking Associations’ Chief Economist Bob Costello has for many months said an “inventory correction” is needed before the trucking industry enjoys higher and more consistent freight demand. Costello and Broughton also have noted that high capacity levels – too many trucks, trailers, railcars, etc. – in the industry has depressed shipping rates, which will only improve when demand improves.

ENCOURAGING SIGNS
Brad Delco, a transportation/trucking analyst with Stephens Inc., believes the truckload industry will soon benefit from inventory corrections and reduced capacity in the industry. Wal-Mart Stores reported U.S. comp store inventory fell by 6% in the third quarter. Kohl’s reported a 9% drop in per-store inventory, T.J. Maxx had a broad 2% inventory reduction, and Macy’s saw comparable inventories fall 3% in the third quarter. Delco said his research showed “a consistent theme around a reduction in inventory levels across the space with an average 2.8% reduction in inventory levels from last year …”

“We remain encouraged by signs of healthier inventory levels (particularly in relation to sales) playing out as demonstrated by 1) 3Q’16 results from the retailers and 2) improving total U.S. inventory/sales data,” Delco, along with Associate Analyst Scott Shoenhaus, posted in a recent investor note. “Building upon similar trends witnessed in 2Q’16, we believe we are seeing signs of an inventory correction, which provides constructive setup for the TLs, particularly given the ongoing supply correction (reduced equipment orders and rightsizing of fleets) and next year’s ELD mandate.”

The ELD mandate is a set of federal electronic driver rules all trucking companies will soon have to use. Although most major players in the industry supported ELD changes, it’s believed added ELD expenses could force some smaller carriers out of business, thereby reducing capacity. In fact, Delco believes the combination of an inventory correction and reduced capacity could prove profitable for the trucking industry.

“These early signs of an inventory correction could be a more meaningful tailwind given the rapid correction we have seen from the supply side for the trucking industry. Recall that industry equipment orders (both tractor and trailer) have fallen meaningfully YTD, with tractor orders falling ~40% yoy (year-over-year) over this period and trailer orders falling ~37%. Additionally, we believe industry capacity has seen reductions as smaller carriers are pressured by higher working capital costs combined with lower rates from customers,” Delco wrote.

Costello also is seeing positive inventory changes.

“I’m pleased with the progress the supply chain has made regarding inventories,” Costello said in a note to Talk Business & Politics. “In September, the latest month available, the inventory-to-sales ratio fell to the lowest level since August 2015. Additionally, the retail inventory-to-sales ratio excluding autos, declined to the lowest level since July 2015. So while there is likely more reductions coming, progress has been made and that will help truck freight volumes going forward.”

Broughton predicted in the September Cass Freight Index that the historic inventory drag could continue through the fourth quarter. He said the risk of recession grows if consumers don’t show up in bigger numbers for the holiday shopping season.