THE STATE OF THE EUROPEAN ROAD FREIGHT INDUSTRY

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1 THE STATE OF THE EUROPEAN ROAD FREIGHT INDUSTRY JOHN MANNERS-BELL MSC FCILT, CEO, TRANSPORT INTELLIGENCE Ladies and gentlemen, I am delighted to have been invited here to speak on the state of Europe s road freight industry. I worked for more than 10 years managing a small family freight company and therefore I have a very good idea of the problems and challenges faced by independent operators. At the other end of the scale I also worked for several years for UPS Logistics Group, which gave me a very different, big company perspective. However big or small, the industry faces some major challenges: congestion, competition, the increasing burden of bureaucracy and a government which has many other priorities. I know this from the time I advised the UK shadow ministerial team on road freight policy, and the great difficulty we had in getting these issues onto the political agenda. Today, I want to provide an independent analysis of how the sector is performing and the main drivers of the industry. Firstly I m going to talk about the market growth in terms of revenues and some of the reasons behind the growth. Secondly I want to talk a little about profit margins and what drives them Thirdly I m going to take on the thorny subject of company bankruptcies and the rising cost of diesel, with some conclusions which may surprise you. HOW HAVE COMPANIES PERFORMED? Firstly let s look at how the major European operators performed in terms of revenues. After a stronger 2011, revenue growth came right down in If I had been standing here a year ago, I would have characterised the industry as being split between a stronger Northern Europe and a weak Southern Europe. However in the past few months the economic contagion of Spain, Italy and Greece has spread. Now all the major road freight companies are complaining about difficult markets including those in Germany and Central and Eastern Europe previously the growth powerhouses of the industry. Here s a snapshot of the majors company results. DHL The Freight business unit generated revenue of 4,192m in 2012, a 0.7% increase over the 2011 result. Transport Intelligence Ltd 1

2 Volumes declined in Scandinavia and the Benelux countries, however higher revenue was generated in Germany and Eastern Europe. DSV Organic revenue growth declined by 1.0%. The European road transport market continued to be adversely impacted by the economic crisis, with freight volumes declining throughout the year in Southern Europe, while Northern European and Eastern European markets suffered particularly in the second half of the year. Decreasing activity in key markets such as Germany and Sweden particularly affected DSV Road. Geodis Road haulage revenues fell by 4.8% Norbert Dentressangle Transport business segment remained resilient with revenue of 2.04bn, an increase of 3.7% year-on-year The company singled-out its pallet distribution business as performing particularly well. The company did admit to losing volumes from some key customers, but said that it had gained market share overall. Dachser European Logistics contributed 2.6bn to the group's revenue, closing the fiscal year with a slight growth of 1.4%. Many of our customers experienced 2012 as an economically extremely unstable year. K+N K+N noted that growth in the European road transport market stagnated. In particular the French and German markets, which were important for this business segment, suffered from the fall in demand in the second half of the year. Providers in the business were exposed to competition and heavy price pressure, which was due to high fuel costs, increased salary costs and the continuing shortage of transport capacity in the local delivery sector. In 2012, the segment reported a 6% increase in revenues Looking at the sector as a whole, if we adjust for inflation, average revenues are where they were in We are also hearing reports of low and unpredictable consumer demand which may be affecting inventory policy. If so, this would represent a major cause of volatility in the road freight market. Transport Intelligence Ltd 2

3 RATES Now you might expect with a flat-lining market, that rates would have been stagnant as well. However this is not the case. Using a Road Freight Price Index which we at Ti have developed in conjunction with Freightex, it can be seen that European road freight rates have now surpassed the peak seen in 2008, just prior to the first recession. It may be slightly surprising given that we are now in the second stage of the double-dip recession that rates have not shown renewed weakness. We ll come onto the reasons for this shortly. WHAT DRIVES PROFIT MARGINS? Let s now turn our attention to the health of the industry and by that I mean its profitability. We ve been tracking profit margins over the last ten years. For most of that time they have remained around the 3.5% mark, although they dropped down markedly in the financial crisis of to about 2.5%. So the question that must be asked is what drives profit margins? This is an area in which we have done a substantial amount of work. For a start and perhaps very surprisingly - we found that margins were not particularly influenced by the price of fuel. It is generally assumed that rising fuel costs are not helpful for road freight operators, as they find it difficult to pass these charges on to customers. Generally the increases are handled better by the larger players, many of whom have agreements in place which result in surcharges being passed on directly. Smaller players either do not have these mechanisms in place or do not have the bargaining power to increase their rates in line with fuel pump costs. One way in which it is possible to test how well the market as a whole is able to pass on fuel cost increases to their customers is by examining the correlation between fuel costs and rates. If rates rise in line with changes in the price of diesel it could be concluded that freight operators are successfully passing on these costs to their customers. In fact from the high correlation (0.85) this does indeed seem to be the case. This is not to say that freight operators do not bear pain. There are significant cash flow implications (especially for medium-sized or small players) which have to outlay significant sums of money up-front for diesel oil. The greater proportion of their cost base which fuel makes up, the larger the problem, as it can take up to 90 days for a haulier to re-coup from customers the amounts paid out. Transport Intelligence Ltd 3

4 STRONGER LINK BETWEEN MARGINS AND SALES VOLUME GROWTH So if profits are not materially impacted by rising fuel costs, what are they affected by? Rather than just looking at input costs, we ran a correlation between volumes and margins, using as our proxy retail sales volume growth. The correlation in this case was much higher than between margins and fuel suggesting that the most important factor for freight transport companies is freight throughput. Freight operators are able to make money once a break even point has been reached on each vehicle or on a network. This break even factor is of course influenced by input costs and freight rates. Our research seems to show that operators are good at managing the breakeven point by passing on increasing costs (or at least a proportion of them) to customers through higher rates. However they are less able to control volumes, especially when the industry is impacted by wider economic crisis. This seems to be the major reason behind fluctuations in profit margins. COMPANY FAILURES Let s now turn our attention to company failures and we can see a complicated picture emerging. As we have seen an endemic lack of profitability characterises the European haulage industry. The logical conclusion of this is that there is a high probability of companies going out of business when faced by any economic headwind. After all from the operating profit the company has to pay: interest and taxes, provide funds for investment in the business and a shareholder dividend. If all the fleet is on operating leases and there are no assets this might be sustainable but on most models a 3.5% margin would not be enough to sustain an asset based trucking business in the long term. Now anecdotal evidence suggests that, at the bottom of the market if you can call it that - there is a continual churn of self-employed owner-drivers who work for and are, in some cases, burnt out by larger companies. These owner-drivers have very little idea of depreciating their assets, in order to be able to replace them at the end of their life. In fact the market is so competitive that even if they did, there is little likelihood that they could work beyond hand-to-mouth. Transport Intelligence Ltd 4

5 It is very difficult to measure company births and deaths in the market at this level, we have to rely on what we are hearing. However for larger companies we are able to measure what is happening as we are able to use government statistics. And here, again perhaps surprisingly, there is a very different story. Company failures are at a five year low, after reaching a peak back in So why the difference between what is happening at the top and bottom end of the market? NO EVIDENCE OF LINK BETWEEN FUEL AND COMPANY FAILURES Now you might expect the rising cost of fuel to be a major causal factor in company failures. The rising cost of fuel is one of the biggest political issues which transport operators and governments face. In the UK it was the reason for a wave of fuel strikes in the early 2000s, with operators making the point that increases in the oil price through market forces and taxation were driving companies out of the market. However in actual fact there seems little evidence for this. Using official company failure statistics and a diesel pump price index there does not seem to be a link between fuel costs and company failures. A strong positive correlation would have been expected if indeed the price of oil was a major factor in transport company bankruptcies; that is to say an increase of diesel would be expected to result in an increase in company failures. So again, if not the cost of fuel, what does influence whether a company goes bust or not?? COMPANY FAILURE AND INTEREST RATES Having lived through the early 1990s recession, when interest rates spiralled to the mid-teens, and having seen the catastrophic impact that that could have on over-leveraged companies, we decided to test out any potential link between interest rates and company failures. Of course, many road freight operators are highly leveraged, leasing road transport assets or borrowing finance to buy them outright. Hence they are exposed to fluctuations in interest rates Having run the figures, this resulted in strong positive correlation suggesting that a rise in interest rates does indeed result in higher company failures. Low interest rate environment may well be one of the key reasons why company failures are around half of what they were four years ago. FREIGHT VOLUMES AND COMPANY FAILURES Rather than solely concentrate on the link between cost pressures and company failures, we also tested the relationship between fluctuating freight volumes and bankruptcies using retail sales as our proxy indicator. Transport Intelligence Ltd 5

6 The logic of this was that the higher the throughput of goods through retail outlets the greater demand for freight transport throughout the entire supply chain as goods are replenished. This tested overwhelmingly positive and the conclusion of this evidence is that road freight transport company health can be directly linked to volumes. Although the economy has been stagnant, retail sales have continued to grow, and hence freight operators have seen low levels of failure. They have coped with higher oil prices by passing these on through higher rates and a low interest rate environment has proved benign. CONCLUSION Looking forward, when economic activity picks up, we can see a scenario when interest rates may well rise to control inflationary pressures (such as created by quantitative easing). If this impacts on shoppers spend, this could create a hostile environment for freight operators i.e. falling volumes and increasing cost of finance. A 'catastrophic rate of failure' amongst smaller providers was not reached in the last downturn. However this is not to say that economic conditions could not create the environment in which this meltdown could take place. To recap: The market works on very low profit margins Companies revenues have stagnated over the past five years, in line with the economy However operators have been successful at passing on fuel costs Margins are more impacted by volumes and less so by fuel or interest rates Capacity has been taken out of the market since 2008/9 and hence rates have risen Company bankruptcies are at a five year low due to low interest rates and stable retail sales High interest rate/high fuel cost/low volume scenario (e.g. QE/geo-political disturbance in Middle East) could fundamentally change the market environment. Thank you very much for your attention today, and I look forward to answering any questions. Transport Intelligence Ltd 6

7 About the Author John Manners-Bell MSc FCILT, CEO of Transport Intelligence, has over two decades experience working in and analysing the global logistics industry. He is Chairperson of the World Economic Forum s Logistics and Supply Chain Global Agenda Council and has advised a wide range of governmental organisations and industry bodies. For more information, contact John Manners-Bell on jmannersbell@transportintelligence.com About Transport Intelligence With a research organisation spanning the world s key markets, Ti is the leading provider of expert analysis dedicated to the global logistics industry. Ti has developed a range of market leading webbased products, reports, profiles and services used by all of the world s leading logistics suppliers, manufacturers, consultancies and banks. All rights reserved. No part of this publication may be reproduced in any material form including photocopying or storing it by electronic means without the written permission of the copyright owner, Transport Intelligence Limited. This report is based upon factual information obtained from a number of sources. Whilst every effort is made to ensure that the information is accurate, Transport Intelligence Limited accepts no responsibility for any loss or damage caused by reliance upon the information in this report. Transport Intelligence Ltd 7