Class 8 orders fall 68%, investor sentiment rises in trucking industry

Net orders of class 8 trucks, the largest truck class, fell in January to the lowest order level in more than two years as orders have fallen over the past several months, and this should be a positive for investor sentiment in the trucking industry, analysts said.

Class 8 truck orders declined 26% to 15,800 units in January, from December, and were down 68% from January 2018, according to preliminary numbers from ACT Research. “January 2018 marked the point at which orders went vertical,” said Kenny Vieth, president and senior analyst for ACT. “We view this January’s order softness as having more to do with pulled-forward orders and a very large class 8 backlog than with the current supply-demand balance. Softening freight growth and strong class 8 capacity additions suggest that the supply-demand balance will become a story in 2019, but January seems a premature start to that tale.”

In a transportation/trucking report, analyst Brad Delco, and associate Scott Schoenhaus, both of Little Rock-based Stephens Inc., explained the orders have been impacted by a high number of cancellations, accounting for about 20% of gross orders. And, this should be good for investor sentiment in the truckload sector, alleviating fears of rising capacity, they said. The backlog of class 8 orders is expected to fall by about 16,000 units because of the weaker order levels.

Investors started to become concerned about capacity growth in 2018 as a result of rising net orders of class 8 trucks and book/build ratios in the first quarter of 2018, according to a transportation/logistics update from senior research analyst Benjamin Hartford and research analyst Andrew Reed, both of Baird. Investor sentiment, asset-based trucking companies’ values and industry stock performance were under pressure as industry growth did not reach a peak until the third quarter of 2018 and orders of class 8 trucks continued to be strong throughout the majority of 2018.

While backlogs of truck orders have fallen, they remain at record levels, said Hartford and Reed. Build rates increased 27% to 324,300 in 2018, from 2017, lagging net order rates that rose 65% to a record of 490,000 in 2018, from 2017. Book/build rates were higher than the long-term average, between 1990 and 2017. The rates declined to 297,200 in December, from 302,100 in October, but were higher than any month before 2018.

Hartford and Reed also noted the similarities between the current period and the late 1990s. In November 1998, net orders declined 38%, book/build ratio was 0.9 and backlogs were lower at 258,000, from 260,600 in October 1998. It took nearly three years of a less than 1 book/build ratio average, two years of builds greater than replacement demand and a U.S. recession in 2001 to bring the backlogs to a low point in late 2001.

“Continued weakness in class 8 net orders and elevated cancellation rates are likely during 2019,” according to Hartford and Reed. “Combined with expected growth in 2019 build rates (of about 335,000, up 5% year-over-year) backlogs should fall through 2019, improving investor sentiment among cyclical truckers on the margin. That said, while annual replacement demand for class 8 units is likely above the implied current level (of about 265,000), incremental fleet growth in 2019 is expected given assumed 2019 build levels, limiting visibility to the timing of a trough in industry yield growth — an important catalyst for cyclical truckers, in our view.”

‘CONTINUED ECONOMIC GROWTH’
Donald Broughton, founder and managing partner of Broughton Capital and author of the Cass Freight Index, said he was not alarmed by the decline in the volume of shipments for the second consecutive month after rising for the past two year because, in December 2017 and January 2018, volumes rose to an all-time high and because the patterns are stabilizing for almost all underlying freight flows.

“Further large percentage increases in the short term are increasingly difficult without significant investments in equipment and technology,” Broughton said. “Setting aside all the intricacies about the limitations on the rate of growth that’s possible on top of already strong growth, the Cass Shipments Index in still signaling continued economic growth.”

The shipments index declined 0.3% in January, from the same month in 2018. Also, it fell 1.2% in January, from December. The expenditures index rose 7.8% in January, from the same month in 2018. But it fell 4% in January, from December.

“The current levels of volume and pricing growth are suggesting that the U.S. economy is still growing, just not at the rate it was, and that it may have reached its short-term expansion limit,” Broughton said. “The full year 2018 percentage increase was 7.9%, which is very robust. “We are confident that the increased spending on equipment, technology and people will eventually result in increased capacity in most transportation modes. That said, many modes are continuing to report ‘limited amounts of capacity.’”

Pricing power is expected to continue until capacity has expanded enough to meet demand, according to Broughton. Once capacity growth exceeds demand, pricing will fall. Pricing would continue to decline until it’s less than the cost of adding new capacity. And at this point, the incentive to add any capacity would be removed, and pricing would become stable as long as demand remains flat.

“If pricing continues to fall dramatically — because either way too much capacity was created or because demand has contracted — capacity will be destroyed or at least idled until pricing stabilizes,” Broughton said. “This process may create significant oscillations in pricing above and below the marginal cost of creating capacity in the short-term, but those increases and decreases in pricing will be around the marginal cost of production.”