For the past year, sharply declining volumes and weak pricing have been the dominant factors impacting companies across the trucking and logistics sectors. We now appear to be moving into a more stabl...
For the past year, sharply declining volumes and weak pricing have been the dominant factors impacting companies across the trucking and logistics sectors. We now appear to be moving into a more stable period of volume gains -and pricing and margin improvements -and while there is still considerable uncertainty about the next 12 months, it is worth looking back at the past year’s trends to understand what we might expect for 2010.
Near Cessation of New Bank Financing
Only the strongest companies were able to secure new financing. Banks have focused on reworking existing loans rather than lending new money. As a result, management teams that had already been in a capacity reduction mode last year quickly enacted another round of cuts and cash-saving measures.
The financial crisis also greatly reduced the amount of funding available to leasing companies and made their business less attractive.
Thus, the number of companies involved in truck leasing has been greatly reduced and those that remain will demand much tighter terms and conditions.
Both of these points suggest that smaller carriers will face much more expensive financing terms than they have in the past, which helped to contribute to an oversupply of trucks. This will help to stabilize the industry’s fleet size and ease pricing pressures from the capacity overhang that has existed over the last few years.
Few Significant Failures
A high level of failures has not materialized for a variety of reasons:
First, the price of oil -and thus, the cost of diesel -dropped dramatically over the past year, leading to substantially lower operating costs for carriers, which worked as an offset against diminished pricing and volumes.
Second, carriers have adjusted their business models to focus on new markets (e. g. repositioning equipment from long-haul markets into regional markets) with demand or to markets that will be driven by stimulus spending.
Third, banks have taken a less aggressive stance with carriers experiencing financial difficulty and have chosen to work with carriers to amend loan agreements and waive covenant restrictions. Thus, troubled carriers have stayed afloat with banks hoping to recover more on the loans outstanding than they would in a bankruptcy process.
The number of failures will likely increase as the economy improves, leading to higher energy costs and better resale markets for trucking equipment. Increased failures will help reduce truck capacity and improve spot pricing. Shippers appear to believe that a number of larger carriers will fail over the next few quarters and are reducing their exposure to troubled carriers.
Return of Mergers and Acquisitions
Companies are beginning to opportunistically pursue M&A as a result of the credit markets opening up. Acquisition strategies are also being helped by lower valuations at target companies driven by reduced levels of EBITDA and profitability. Several significant transactions have been announced since the summer:
• Canada Pension Plan’s and Sterling Partners’ $400 million purchase of Livingston.
• TransForce’s $85 million acquisition of ATS Andlauer’s retail division.
• MacKinnon Transport’s merger with Walker Group.
Going forward, large operators with strong, free cash flow and balance sheets are likely to begin reviewing acquisition opportunities with a specific interest in consolidating traditional end markets and diversifying customer bases. In addition, pension funds are expected to show significant interest in stable, cash-producing firms that have a high degree of integration with customers, newer fleets and low capital expenditures.
Public Company Restructuring and Balance Sheet Flexibility
With the end of the income tax holiday fast approaching for income trusts, a number of public trucking companies have announced conversions to a corporate structure. Both TransForce (May 2008) and Mullen (May 2009) chose to convert well in advance of 2011 to facilitate positioning for growth. Adopting the corporate structure leads to significant reductions in distributions and provides balance sheet strength. More recently, Contrans Income Fund completed its conversion to a corporate entity, Contrans Group Inc. Only Cargojet and Trimac remain structured as income trusts and can be expected to announce their plans prior to the end of 2010.
Recently, a number of publicly traded companies have accessed the equity markets to either provide covenant relief on existing bank financing or to ensure financial flexibility:
• Vitran reduced debt with a US$23-million issue and negotiated improved loan covenants and an extended covenant period to December 2010.
• TransForce completed a $50-million offering that provided proceeds for debt repayment in the near term and flexibility for making acquisitions in the future.
• Livingston executed a $40-million financing as part of a debt repayment strategy.
• Mullen announced a $125-million offering to ensure liquidity in a difficult operating environment.
Each of these offerings was well-received by investors who took bets on the economy continuing to recover, freight volumes growing, and pricing rebounding.
Economy Improving Slowly
Canadian consumer spending, which accounts for approximately two-thirds of the economy, has been restrained as consumers have cut back their discretionary spending due to lower stock portfolios, a tepid housing market and employment uncertainty. The reality is that discretionary consumer spending is not expected to return to pre-financial crisis levels, which will have a direct impact on trucking volumes. However, there are a number of indicators that are signaling a step increase in future demand:
• Inventory-to-sales ratios for retailers have declined, which should signal significant demand for trucking as retailers rebuild inventory.
• Canadian industrial production has been improving with the IVEY purchasing managers index showing expansionary activity (above 50 reading) since July after a significant decline in the second half of 2008.
Elian Terner is a director in the Investment Banking Group of Scotia Capital (a division of the Scotiabank Group). He regularly advises transportation and logistics companies on financing and strategic initiatives. He can be reached at firstname.lastname@example.org.