Pricing turmoil clouds outlook for LTL market

When does rate-cutting morph into throat-cutting?

That may be a reasonable question for trucking executives to ponder as they start 2010. That is, if they aren't too busy beating each other up over pricing to think through the consequences of their actions.

As a grinding freight recession ended its third year, the rate environment for truckload and, in particular, less-than-truckload (LTL) services, continued to weaken. Pricing trends in both categories deteriorated considerably in the third quarter from the first half of 2009, according to data culled from company reports and compiled by investment banker JPMorgan Chase. Even railroad pricing on commodities for which the rails compete with truckload carriers has been hurt by the weakness in truckload rates, according to the firm. Only ground and express parcel services showed a sequential pricing improvement through the first three quarters of 2009, according to the JPMorgan data.

Industry veterans have rarely seen anything like it. Michael Regan, CEO of TranzAct Technologies Inc., an Elmhurst, Ill.-based consultancy that over the years has negotiated and purchased billions of dollars of LTL capacity for shipper clients, says he's seen discounts of as much as 90 percent below retail, or tariff, rates.

The pain is being felt across the carrier spectrum. For example, two of the healthiest LTL carriers, Old Dominion Freight Line Inc. and Con-way Inc., posted sub-par revenue and net income results in the third quarter of 2009, with the top executives at both companies attributing their respective performances to declines in tonnage and aggressive pricing competition.

"Overall, the business environment continues to present formidable challenges, characterized by weak demand, excess capacity, and pricing pressure. We expect these conditions to persist in the near term, diminishing the prospects for earnings growth," Con-way President and CEO Douglas W. Stotlar said in a statement accompanying his company's results.

William D. Zollars, chairman and CEO of YRC Worldwide Inc., the nation's largest LTL carrier, said he doesn't expect a meaningful economic or freight rebound during the first half of 2010 and that rate weakness will likely continue at least through that period. In an interview with TranzAct's Regan, Zollars said YRC has been disciplined about pricing, noting it increasingly walks away from freight it deems to be unprofitable.

"We don't want to be acting like our competitors who are 'fire-saleing' things for various reasons," Zollars said in the interview.

Yet that didn't stop YRC from discounting its rates by as much as one-third through at least the end of 2009. Jon A. Langenfeld, a transport analyst for Milwaukee-based Robert W. Baird & Co. who reported the YRC move in a recent research note, said the action represents more "pricing aggression" that will impede a meaningful recovery in prices and negatively impact LTL profitability well into 2010.

Self-inflicted wounds
For carriers, the wounds have been largely self-inflicted. Beset by soft freight flows and persistent overcapacity—the consensus among analysts is that there is 20 percent excess capacity in the LTL sector—truckers have spent the better part of 2009 slashing rates to win or keep business.

At the same time, carriers remained loath to remove capacity, keeping the supply-demand scale firmly tilted in favor of shippers. Satish Jindel, head of SJ Consulting, a Pittsburgh-based consultancy, says with the exception of YRC, no major LTL carrier took out capacity in more than single-digit amounts last year. By contrast, YRC removed up to 30 percent of its capacity by shuttering several regional operations and cutting 190 terminals from its YRC National unit during the 2009 integration of Yellow Transportation and Roadway Express into the new entity.

Most of the predatory pricing was aimed at taking share from YRC to drive the financially troubled carrier out of business and eliminate a large source of supply. However, it appears those plans will have to be put on hold. A November 2009 agreement under which YRC's bondholders planned to exchange their debt for 1 billion newly issued equity shares—a deal that will allow YRC to eliminate nearly $400 million in 2010 interest payments and give it access to a revolving credit line of more than $100 million—is likely to keep the trucker afloat at least through the end of 2010. This gives YRC critical breathing space to remain competitive with a smaller, more efficient network that Zollars said "fits our business volumes pretty well." At this writing, the swap had yet to be consummated.

Faced with the prospect of a surviving and perhaps recovering YRC, its rivals may take the pedal off the pricing metal and look for different ways to remain competitive. "We think carriers, once they realize YRC's financial situation isn't as precarious as it was, may step back and create some stability in pricing," says Jindel.

That could actually be good news for shippers, who while being the beneficiaries of a year-long rate gift that kept on giving, understand that in the long run, a carrier's inability to earn an adequate return may deter it from making the investments needed to deliver a quality product.

Regan of TranzAct believes shippers have picked most of the low-hanging rate fruit and should not expect carriers to slash prices much further for fear of failing to cover even their variable costs. "The bigger shippers have already grabbed the bulk of the savings that are there," he says. Regan expects LTL rates to remain flat year over year, barring any unexpected developments.

Light at the tunnel's end?
There may be some light at the end of this very dark tunnel. Truckload rates, which normally lead LTL pricing by many months, appear to have bottomed in late 2009 and are poised for an upward spike. If history is any guide, LTL rates should firm up sometime in 2010.

But these are not ordinary times. Unlike the LTL category, the truckload sector has already seen a significant reduction in capacity during the recession. LTL overcapacity is likely to remain an issue even after freight volumes recover.

Another and perhaps more profound trend is a shift in what Jindel called a shipper's "product characteristics." Tonnage has traditionally been the bread and butter of LTL carriers. Yet the goods being produced today are lighter and smaller than ever before, leading to painful declines in tonnage tendered to the carriers.

Jindel says much of this lighter, smaller freight is being increasingly "converted" to parcel services, a factor that may explain why parcel pricing held up relatively well through most of 2009. The analyst says the shrinking in cargo size and weight is a long-term trend, and LTL carriers must reposition their value propositions accordingly or risk losing more business to parcel companies. "This is a more important long-term issue for LTL than pricing," he says.