(By
Matthew Young, CFA) The
recent freight recession decimated the profitability of most
less-than-truckload (LTL) carriers, primarily because the industry is
marked by asset intensity and minimal switching costs--factors that
drive our no-moat ratings for all pure-play LTL stocks in our coverage
universe. Profitability is thus quite cyclical with limited protection
from the competitive landscape, particularly during periods of weak
freight demand. Consequently, throughout 2009 as freight volume tumbled,
numerous struggling carriers on the brink of collapse slashed rates to
unsustainable levels in a desperate attempt to grab volume and stay
afloat. Nonetheless, industry pricing (yield) reached a key inflection
point in the latter half of 2010 as capacity utilization improved. Since
then, carriers' yield gains have largely continued. Although
year-over-year growth comparisons become a bit more difficult in the
second half of 2011, we expect favorable pricing conditions to remain a
tailwind. In fact, pricing execution has become the focal point for most
LTL carriers as they endeavor to recapture normal operating margins.
The chart below depicts LTL industry yield trends over the past few
years. Excluding the recent, rapid rise in fuel surcharges, we estimate
base rates increased 3%-4% year over year on average in fourth quarter
2010 and first quarter 2011. In general, recovering freight demand and
the return of rational rate setting among the industry leaders have
supported the pricing improvement. More specifically, rising volume has
consumed excess capacity, enabling carriers to launch aggressive
initiatives aimed at shoring up historically low yields. These efforts
have been particularly focused on underpriced contractual business, and
negotiations have met with success. Con-way (CNW), Arkansas Best (ABFS), and Old Dominion (ODFL),
for example, all generated mid-single-digit rate increases on average
in first-quarter contract negotiations. Moreover, most of the major LTL
carriers implemented two general rate increases (each around 6%) during
2010. Encouragingly, a significant portion of these GRIs appears to be
sticking.
Looking forward, we expect core LTL-industry pricing to expand 3%-5%
on average in 2011 followed by low-single-digit growth in 2012.