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The topics explored in this issue will be discussed at the eyefortransport 'The Impact of High Fuel Prices on Logistics' Summit - December 8/9 Los Angeles
The Impact of High Fuel Costs on Mergers & Acquisitions in the Trucking Industry
by Douglas Christensen, Managing Director with Chapman Assocates
The trucking industry has gone through, and continues to go through, some of the most difficult times since the Motor Carrier Regulatory Reform and Modernization Act of 1980. Deregulation effectively eliminated scores of major carriers over a ten year period as carriers fought for survival. The year 2008 is shaping up to be just as difficult as we are experiencing what can best be described as a “Perfect Storm”. There are five key events that are occurring simultaneously:
- Skyrocketing fuel prices
- Major reductions in economic activity
- Massively changing supply chains
- Falling US dollar
- Significant pockets of debt secured by trucking assets
Skyrocketing fuel prices are creating significant costs for truckload carriers that cannot be fully recovered through existing fuel surcharge formulas. The inherent problem with these fuel surcharge formulas is that they are based on loaded miles only. All truckload carriers (other than dedicated contract carriers) have an inherent number of miles that they must run empty when dropping off one load and picking up the next load. Some carriers manage this very well by optimizing their customer shipping and delivering points. Large carriers have enough customer diversification that they have plenty of loads to choose from. All carriers, though, pay for the fuel they use for every mile that they run empty. The chart below illustrates what this costs for a tractor each year at ranges between $1.50 and $5.00 per gallon for diesel fuel. Each chart assumes 120,000 miles per year, per tractor, and an average of 6.8 miles per gallon:
As you can see, the simple rise from $2.00 per gallon to $5.00 per gallon, using a moderate 10% empty miles factor, is a $5294.12 per tractor, per year, hit to the bottom line of a truckload carrier. Using average revenue per mile of $1.65 per mile, as an example, generates $198,000 per year, per tractor. This extra fuel cost represents 2.7% degradation in income margin. This could be the entire income of a marginal carrier.
With major reductions in economic activity there is less freight being shipped. Smaller carriers in particular are doing more chasing to find backhaul freight. This increases the number of empty miles driven by a carrier. With LTL carriers there is a secondary effect from rapidly rising diesel fuel prices. Fuel surcharges are passed on based on the previous week’s fuel prices. When diesel prices rise very rapidly there is a lag between the fuel surcharge rate and the price of diesel fuel purchased that week. This has an immediate impact on earnings. Conversely, this is a benefit when diesel prices fall rapidly as well. As an additional contributing factor to a drag on earnings, lower economic activity results in smaller average shipment sizes for LTL carriers. It costs generally the same amount to pick up an 800 pound shipment as it does an 840 pound shipment but there is less revenue. The same is true for delivery costs. This has a direct impact on the bottom line of LTL carriers.
As the cost of a gallon of diesel fuel rises rapidly, this creates a major impact on the costs of certain products which will result in significant changes in those supply chains. Case in point – lettuce and other produce. With recent diesel fuel prices approaching $5.00 per gallon, this results in a $1.00 fuel surcharge for refrigerated goods. These types of commodities cannot simply wear the cost of transportation across great distances anymore. This will result in more locally grown produce and other lower value products being warehoused locally. This also increases the cost of imported goods as steamship companies pass on their fuel surcharges coupled with an already weakened dollar. Near-sourcing for supply chains then becomes more popular versus production in Asia.
A weakened US Dollar is actually creating a double phenomenon with imports slowing and exports rising. This changes the freight flows both domestically and internationally. Is it dramatic? No, but it all has an impact on changing supply chains.
In the first six months of 2008, 1,908 trucking companies have closed their doors and liquidated or gone bankrupt. This has resulted in approximately 120,000 tractors leaving the roads. A 6% drop in trucking capacity. While an estimated 30,000 of these used tractors and trucks have been shipped overseas, this represents a significant flooding of used equipment into the marketplace. Prices for used tractors and trailers have fallen like a rock. The trucking industry has historically been an asset intensive business. This has generated a significant amount of debt to be continually reinvested in new equipment. The first sources of collateralization are the tractors, trailers and trucks. There is no clear estimation of how much debt actually exists in the trucking industry where the debt exceeds the value of the assets. This potentially looming crisis is not something that is written about in the press but certainly exists. This is a situation not likely to change anytime soon unless economic activity increases.
What does all of this mean to merger and acquisition activity in the trucking business today? There are numerous owners of trucking businesses that would like to sell their business before the bank forecloses or they are forced to close their doors due to losses. These distressed businesses are selling at very attractive prices. In some instances they are going for just the market value of the assets. In other cases there is a slight premium of 3% - 6% of the revenue for the customer base. It is a buyer’s market for these marginal carriers and many successful trucking business owners are taking advantage of this market condition. If your balance sheet is strong and your management team capable, this is a terrific period to add geographic coverage, new service offerings, or just more volume and density at a very low cost. Not unlike the aftermath of the Motor Carrier Act of 1980, this is a time where the strong carriers get stronger and the weak carriers get weaker.
Private Equity Funds and Hedge Funds are now circling the marketplace. Their investment thesis is that with reduced capacity; pricing will rise (which it is now doing in the truckload market segment). Additionally, some of these larger carriers that have significant amount of debt are also looking attractive as that debt begins to trade down in value. They will insert stronger management (which is supposed to be strong suit of Private Equity), put a stronger focus on growing non-asset services and bet on an economic recovery. A private equity firm can exit this investment in three to five years with an attractive return from their original bargain priced investment.
What does this mean to profitable carriers? The M&A market is still alive but slower. Valuations are trending closer to 2X – 3X EBITDA based on an efficient mix of assets. Obviously, significant investments in land or specialized rolling stock change these numbers.
Non-asset or asset light logistics companies are mostly unaffected by high fuel costs. This segment continues to grow and thrive in difficult economic times. Client volumes do fall and this is usually reflected in lower variable revenue. The merger and acquisition activity for this segment is extremely strong. There are just not enough logistics companies that are willing to sell to meet buyer demand.
I was prepared, until the banking meltdown, to predict the beginning of a financial recovery for truckload carriers. Real GDP was up 3.3% in the second quarter of 2008, capacity is down and pricing is on the rise. Unfortunately, these are extremely volatile times that suggest that meaningful economic recovery that drives freight volumes is probably sometime well into 2009.
In summary, what does this mean for Merger & Acquisition activity for the logistics industry in a high fuel cost economy?
- Buyers market for distressed trucking companies
- Trucking business valuation fundamentals are improving
- Credit risk on trucking equipment debt is rising
- Decent market for profitable trucking companies
Still as a seller’s market for non-asset logistics companies.
Doug Christensen is currently Managing Director for Chapman Associates, a middle market M&A firm that specializes in the logistics industry. Doug was formerly a third party logistics senior executive for 27 years before joining Chapman early last year. He can be reached at firstname.lastname@example.org or (847) 540-8170.
Fuel Prices Drive Home the Urgency to Rethink Supply Chain Technology Strategies
By Jim Burleigh, CEO of SmartTurn (www.smartturn.com)
Remember three years ago when fuel prices spiked significantly and forced logistics carriers to drastically rethink how they conduct business? This along with natural and man-made disasters such as the hurricanes in the Gulf of Mexico and the Enron energy crisis in California during the 1990s drove businesses to adapt to a new environment. Those that weren't agile enough disappeared.
Not surprisingly, such events create turmoil in the stock markets, affect buyer confidence, and impact supply chain dynamics. If brands and manufacturers do not adapt quickly to demand on the sell-side, they face bleak futures, as do their logistics service providers, 3PLs and warehousing centers. Pressures to provide both inventory visibility and adaptive measures to support pull-supply chains have also emerged because of "Web 2.0", a paradigm focused around the behavior of individuals, companies and social networks that influence buying habits as a result of the Internet. This is the arrival of the "experience economy" where customers want a 360-degree experience that includes things such as carbon footprints, real-time product visibility, and availability/delivery times among others.
If you don't provide customers with what they want, when they want it, and at a reasonable price, your organization is at risk. The supply chain is more critical than ever to your organization's success. Market demands to improve performance while simultaneously reducing costs is changing the playing field, and highlights the need for technology to support both the agile, fuel-efficient supply chain as well as for socially responsible green initiatives.
Technology has always been a differentiator for companies as they evolve their business practices. What is not apparent for the logistics community is how far technologies have advanced and how easily available it is with tipping point changes such as Software-as-a-Service (SaaS), on-demand, staged buying experiences supported by consumer access to web-based information (search engines, web-networks, portals, etc.). The big dilemma for supply chain professionals is "how long can they hide the dust under the carpet". In other words, you need to determine truly measurable inefficiencies and wastage within your supply chain. Volatile fuel prices and stock market turmoil highlight an endemic problem-rigid supply chains and logistics inefficiencies playing foul with higher goals (e.g. going "green").
While transportation carriers are sensitive to fuel prices, manufacturers face energy surcharges. This uncertainty along with current economic conditions affects the growth of inventory. The consequences are far reaching since shippers will carry extra inventory or safety stock, and order less frequently, adopting a cost-reducing strategy to select a cheaper, slower mode of transportation. Most consumers already feel the effects through higher food and packaged good prices. These same vendors are also dealing with more items and orders, shorter lead times, and higher expectations for service levels. Manufacturers are uncomfortable with static supply chains that are physically unwieldy and bound by insular, legacy order management, procurement or fulfillment systems.
Outsourcing to China seemed cost effective a few years ago, but today it's no longer the "supply chain bargain" it once was. Escalating labor costs and ever-increasing government regulation are creating reverse globalization. As the world becomes smaller, moving offshore isn't a cost-effective way to outsource. Instead, companies view outsourcing from a more strategic perspective with a deeper understanding for what the business demands. Pull-based supply chains are again becoming popular, displacing push-based initiatives that encouraged off-shoring manufacturing and other long-lead, long-life transit time strategies to market. Most forecasting techniques fall short of actual market dynamics, resulting in over-stocking, obsolescence and poor customer service levels. Unless changes are made, the value chain will continue to plod on with shrinking margins.
Companies like Sharp Electronics are shifting their final assembly closer to point of sale, a return to the practices of the 1980's and 90's prior to off-shoring becoming a no-choice option for manufacturers to survive. Normalization of China's economy with the global economy has resulted in a reorganization of supply chain networks.
An equal level of discussion also surrounds the issue of the green supply chain. While the majority of investment tied to corporate social responsibility programs, a green strategy provides prudent business processes. Such a framework emphasizes network redesign, packaging changes and business collaboration that promote a smaller carbon footprint and generates cost savings.
Rethinking Your Supply Chain
- To ensure your warehouse operates efficiently, you need a warehouse management system (WMS) now. The most strategic way is also the most fundamental-improve supply chain "visibility" and tactical knowledge, to help close the gap between the time you learn about something with significant impact and when you can actually do something about it. Without a WMS, you're at a huge cost disadvantage. An increase from 91% accuracy to 99% can mean saving thousands of dollars each month for your warehouse. For example, SmartTurn's on-demand, web-based system improves visibility and accuracy, while also reducing the carbon footprint of all products running through a WMS. Paper usage in a warehouse can be reduced by 80%, IT expenditures by 95%, computer power usage by 70% (enterprise-class server setups require significant power, approximately $900 to $1,400 annually!).
- One of the biggest shortcomings in the industry is the lack of communication and accessibility to information. A good analogy is today's high school teenager. On a typical day, 80% of teenagers send or receive a text, IM, or email, according to estimates. My guess is that it's less than 10% for the logistics industry, most with little or no access to information necessary to make key decisions.
- We need to look at our supply chain networks with a sense of urgency which means developing an understanding of future economic conditions. Review your customer list for profitability. As logistics costs increase, margins shrink, so assess whether letting go of a customer makes more sense.
- Carriers of all types need to take collaboration to heart by developing an action plan and adopting industry-wide best practices. If now isn't the time, then when will it be?
- When making offshoring decisions, fuel prices may make a close-to-home strategy more financially feasible. From an efficiency and optimization standpoint, cost savings from labor are easily negated when transportation expenses come into play.
Unlike other trends that become fads, fuel prices are a long-term, if not permanent, part of the logistics landscape and will impact how we do business today and in the future. While the challenges may change, the fundamentals of good business remain the same.