Current Affairs
May 23, 2022
More on Inventories
Bloated inventories hit Walmart, Target and other retailers’ profits, trucking demand
Too much stock means lower truckload volumes, more intermodal business
Mark SolomonFriday, May 20, 2022 4 minutes read
Listen to this article 0:00 / 6:18 BeyondWords
There’s little in retailing that Walmart Inc. and Target Corp. aren’t prepared to handle. So it was jarring that over a 24-hour period the two scions of the trade posted weak first-quarter profits that appeared to blindside their management teams.
Part of the bottom-line blowup was due to fuel, which soared to record highs following Russia’s Feb. 24 invasion of Ukraine. Part of it was due to margin pressures caused by an unfavorable sales mix as consumers shifted their buying from higher-margin goods like electronics to less profitable items like groceries. An extension of that was an overshoot of inventory-stocking activity, which came back to bite the retailers after waning concerns over the COVID-19 pandemic pushed more consumer buying toward services and “experiences” and away from goods.
There’s little that retailers can do about fuel prices. It can be argued they should have expected the pandemic-driven buying spree from March 2020 until the end of 2021 to peter out and that they should have planned their inventory strategies accordingly. Yet demand forecasting has always been a tough nut to crack, and the market is where it is. Inventory build may also have been the result of supply chain delays at the start of the year that resulted in some late deliveries of impaired freight.
Inventory levels as of March, when compared to activity in March 2019 after inventories stabilized following a major pull-forward in 2018 ahead of the Trump administration’s China tariffs, produce a mixed bag of results. Unsurprisingly given the current dearth of motor vehicles, the ratio of vehicle and parts inventories to sales has fallen considerably, according to federal government data analyzed by Michigan State University. Apparel inventories to sales also declined over those periods, as did e-commerce.
However, furniture, home furnishings and appliances, building materials and garden equipment, and a category known as “other general merchandise,” which includes Walmart and Target, among others, reported higher inventory-to-sales ratios, according to government data analyzed by Michigan State.
For the latter sectors, the change has happened fast, according to Jason Miller, logistics professor at MSU’s Eli Broad College of Business. As of November, inventory-to-sales ratios were at pre-COVID levels, Miller said. They have since exploded upward.
Miller said he expects a “cooldown” in retailer order volumes, even if inflation-adjusted sales stay constant, as retailers look to reduce their existing stock. He also expects retailers to launch major discounting programs to expedite the inventory burn. Fewer orders within certain categories bodes ill for carriers whose networks are strongly tied to inbound lanes to retailers’ distribution centers, Miller said.
In a Friday note, Bascome Majors, analyst for Susquehanna Investment Group, said that the spread between year-over-year sales and inventories — a rough barometer of the impact of higher sales on restocking activity — turned positive in spring 2020 and accelerated in favorable territory for four consecutive quarters. Gradually, however, the spread has turned negative, according to Majors. In this year’s first quarter, inventory growth exceeded sales growth by 200 basis points. The recent surge in inflation, Majors wrote, has severely distorted inventory and sales trends.
Freight recession priced in?
For some, high inventory levels are an expected occurrence and should be welcomed. In a Tuesday note, Amit Mehrotra, transport analyst at Deutsche Bank, said rising buffer stock is part of retailers’ desire to have goods available when consumers scan the shelves. Mehrotra added, however, that the data points translate into a likely slowdown in freight flows in the coming months and quarters.
He said that a recession is already priced into most transportation equities, noting that the shares of most trucking companies are higher over the past 30 days while the broader market is about 7% lower.
In an unusual world, Walmart, Target and other retailers are likely to turn to the one area where they’ve traditionally found leverage: their shipping bill. During the quarter, Target (NYSE: TGT) faced freight and transportation costs that were hundreds of millions of dollars above already-elevated expectations, COO John Mulligan said on the company’s Wednesday analyst call. It was essentially the same story at Walmart (NYSE: WMT).
Retailers’ efforts to rein in transportation costs will translate into an unprecedented third and even fourth round of truckload contract negotiations, with users getting more aggressive in their bids to extract greater cost savings, according to industry experts.
The discussions could get contentious. In a LinkedIn post on Friday, Jason Ickert, president of trucking firm Sonwil Logistics, said a large shipper that Ickert wouldn’t identify suggested on a conference call this week with truckload carriers that they were “artificially propping up their rates” above accepted market levels. The shipper “stated clearly” that the carriers were expected to adjust their rates during what would be an “unprecedented and unplanned” third round of request for proposals, Ickert wrote.
A potential shift to intermodal
Pressures to drive down transport expenses will also trigger increased interest in intermodal, whose all-in costs are cheaper relative to contract truckload than at any time since 2018. Intermodal rates have risen at a slower pace than truckload contract rates, a turnabout from the 2019 freight recession when higher intermodal rates allowed over-the-road transport to gain market share.
The shift to intermodal, if it happens, would benefit the railroads and intermodal marketers like J.B. Hunt Transport Services Inc. (NASDAQ: JBHT), Hub Group Inc. (NASDAQ: HUBG) and Schneider Inc. (NASDAQ: SNDR). However, experts caution that intermodal capacity remains constrained, as does warehouse space needed to store the stuff.
“Walmart, Target and other retailers will soak up every drop of intermodal capacity that Hunt, Hub, Schneider and the rails deliver in 2022 and probably in 2023,” said Majors of Susquehanna Investment Group. The elevated level of activity, he said, should occur even if retailers are working through a multiquarter process of de-stocking.
May 23, 2022
More on Inventories
Bloated inventories hit Walmart, Target and other retailers’ profits, trucking demand
Too much stock means lower truckload volumes, more intermodal business
Mark SolomonFriday, May 20, 2022 4 minutes read
Listen to this article 0:00 / 6:18 BeyondWords
There’s little in retailing that Walmart Inc. and Target Corp. aren’t prepared to handle. So it was jarring that over a 24-hour period the two scions of the trade posted weak first-quarter profits that appeared to blindside their management teams.
Part of the bottom-line blowup was due to fuel, which soared to record highs following Russia’s Feb. 24 invasion of Ukraine. Part of it was due to margin pressures caused by an unfavorable sales mix as consumers shifted their buying from higher-margin goods like electronics to less profitable items like groceries. An extension of that was an overshoot of inventory-stocking activity, which came back to bite the retailers after waning concerns over the COVID-19 pandemic pushed more consumer buying toward services and “experiences” and away from goods.
There’s little that retailers can do about fuel prices. It can be argued they should have expected the pandemic-driven buying spree from March 2020 until the end of 2021 to peter out and that they should have planned their inventory strategies accordingly. Yet demand forecasting has always been a tough nut to crack, and the market is where it is. Inventory build may also have been the result of supply chain delays at the start of the year that resulted in some late deliveries of impaired freight.
Inventory levels as of March, when compared to activity in March 2019 after inventories stabilized following a major pull-forward in 2018 ahead of the Trump administration’s China tariffs, produce a mixed bag of results. Unsurprisingly given the current dearth of motor vehicles, the ratio of vehicle and parts inventories to sales has fallen considerably, according to federal government data analyzed by Michigan State University. Apparel inventories to sales also declined over those periods, as did e-commerce.
However, furniture, home furnishings and appliances, building materials and garden equipment, and a category known as “other general merchandise,” which includes Walmart and Target, among others, reported higher inventory-to-sales ratios, according to government data analyzed by Michigan State.
For the latter sectors, the change has happened fast, according to Jason Miller, logistics professor at MSU’s Eli Broad College of Business. As of November, inventory-to-sales ratios were at pre-COVID levels, Miller said. They have since exploded upward.
Miller said he expects a “cooldown” in retailer order volumes, even if inflation-adjusted sales stay constant, as retailers look to reduce their existing stock. He also expects retailers to launch major discounting programs to expedite the inventory burn. Fewer orders within certain categories bodes ill for carriers whose networks are strongly tied to inbound lanes to retailers’ distribution centers, Miller said.
In a Friday note, Bascome Majors, analyst for Susquehanna Investment Group, said that the spread between year-over-year sales and inventories — a rough barometer of the impact of higher sales on restocking activity — turned positive in spring 2020 and accelerated in favorable territory for four consecutive quarters. Gradually, however, the spread has turned negative, according to Majors. In this year’s first quarter, inventory growth exceeded sales growth by 200 basis points. The recent surge in inflation, Majors wrote, has severely distorted inventory and sales trends.
Freight recession priced in?
For some, high inventory levels are an expected occurrence and should be welcomed. In a Tuesday note, Amit Mehrotra, transport analyst at Deutsche Bank, said rising buffer stock is part of retailers’ desire to have goods available when consumers scan the shelves. Mehrotra added, however, that the data points translate into a likely slowdown in freight flows in the coming months and quarters.
He said that a recession is already priced into most transportation equities, noting that the shares of most trucking companies are higher over the past 30 days while the broader market is about 7% lower.
In an unusual world, Walmart, Target and other retailers are likely to turn to the one area where they’ve traditionally found leverage: their shipping bill. During the quarter, Target (NYSE: TGT) faced freight and transportation costs that were hundreds of millions of dollars above already-elevated expectations, COO John Mulligan said on the company’s Wednesday analyst call. It was essentially the same story at Walmart (NYSE: WMT).
Retailers’ efforts to rein in transportation costs will translate into an unprecedented third and even fourth round of truckload contract negotiations, with users getting more aggressive in their bids to extract greater cost savings, according to industry experts.
The discussions could get contentious. In a LinkedIn post on Friday, Jason Ickert, president of trucking firm Sonwil Logistics, said a large shipper that Ickert wouldn’t identify suggested on a conference call this week with truckload carriers that they were “artificially propping up their rates” above accepted market levels. The shipper “stated clearly” that the carriers were expected to adjust their rates during what would be an “unprecedented and unplanned” third round of request for proposals, Ickert wrote.
A potential shift to intermodal
Pressures to drive down transport expenses will also trigger increased interest in intermodal, whose all-in costs are cheaper relative to contract truckload than at any time since 2018. Intermodal rates have risen at a slower pace than truckload contract rates, a turnabout from the 2019 freight recession when higher intermodal rates allowed over-the-road transport to gain market share.
The shift to intermodal, if it happens, would benefit the railroads and intermodal marketers like J.B. Hunt Transport Services Inc. (NASDAQ: JBHT), Hub Group Inc. (NASDAQ: HUBG) and Schneider Inc. (NASDAQ: SNDR). However, experts caution that intermodal capacity remains constrained, as does warehouse space needed to store the stuff.
“Walmart, Target and other retailers will soak up every drop of intermodal capacity that Hunt, Hub, Schneider and the rails deliver in 2022 and probably in 2023,” said Majors of Susquehanna Investment Group. The elevated level of activity, he said, should occur even if retailers are working through a multiquarter process of de-stocking.
May 20, 2022
Giant Container Ship History
Giant container ships are ruining everything
We can blame the Big Boat Era for many of our supply chain headaches
Rachel PremackThursday, May 19, 2022 7 minutes read
Listen to this article 0:00 / 10:53 BeyondWords
I hate big boats, and so should you.
In 2006, Maersk stunned the global shipping community with the introduction of Emma Maersk, a container ship that could carry nearly 15,000 twenty-foot equivalent units. (TEUs translate to about half of a standard forty-foot shipping container.)
Emma Maersk set off an “arms race” with its introduction. Ocean carriers ordered bigger and bigger ships, believing that they could reach economies of scale if they could jam all their shipments into one big boat instead of a few small ones.
Today, we’ve appeared to reach peak Big Boat Era. The Emma Maersk is now wimpy next to 2022’s true megaships. The largest container ships to be delivered this year have a maximum capacity of 24,000 TEUs. (This class of ship is named — I am not making this up — the “Ever Alot.” The Evergreen shipping company, the very same that blocked the Suez Canal last year, ordered the record-breaking ship.)
Each year brings a new, larger-than-ever megaship. The largest ship class of a given year has increased by 50% from 2012 to today, or nearly sixfold from 1981 to today.
Massive container ships have helped wreak serious chaos on global trade. I spoke with four experts this week to learn how megaships are the sneaky reason for much of our ongoing shipping crisis.
Here are the three reasons I hate big boats:
1. They underpin the global shipping oligopoly.
Global shipping is dominated by a few giant firms. But it wasn’t always this way.
In the 1970s, there were so many ocean carriers that no single company controlled the industry. Since then, the market has consolidated into just a few large firms.
Up to 60 of the 100 largest ocean carriers have vanished from the 2000s to today, thanks to a wave of bankruptcies and acquisitions. The top 10 largest ocean carriers in 2000 commanded 51% of the market; today, they dominate 80% of it, according to a White House fact sheet. All of these companies are based outside the U.S.
Smaller ocean carriers began forming alliances with each other in order to compete with larger carriers, said Campbell University professor Sal Mercogliano. Megashippers decided to copy the strategy. Today, the largest ocean carriers are organized into three major container shipping alliances: 2M, The Alliance and Ocean Alliance.
To ship something from, say, China to Los Angeles, you book space on a container ship operated by one of these alliances. Each company shares space on the container ship with other members of the alliance. But these alliances may cancel — or have “blank sailings” — if demand has slumped.
This system has been great for the carriers’ own financial performance. Some claim this consolidation and the alliance system lead to inflated rates.
The Loadstar, a global logistics publication, reported on April 22 that the 2M alliance was blanking at least three Asia-North Europe sailings. New Chinese COVID lockdowns were one reason for the cancellation, but Loadstar also pointed to 2M’s desire to “halt the slide in rates” amid a slump in volume from China. More canceled sailings mean less capacity for cargo, and likely higher rates.
Container ships have been steadily increasing in size since they were created in 1956. But it wasn’t until the 2000s that the Big Boat Era truly began, Mercogliano said. Ocean carriers believed they could reach economies of scale if they built giant ships. The idea was to put all of your cargo on one massive ship instead of two or three smaller ones.
Such megaships were expensive. Emma Maersk, for example, cost an estimated $145 million. But banks were happy to provide the cash, said Capt. John Konrad, CEO of maritime website gCaptain.
Konrad told FreightWaves that ocean carriers are ideal lending targets. If an ocean carrier defaults on its loan, you can simply repossess any of its ships. And, conveniently, many receive hefty subsidies or other support from the governments of the countries they’re based in. Before the financial crisis, banks were happy to provide massive loans to ocean liners to build the megaships of their dreams.
Then 2008 happened. As Mercogliano said, “The freight dried up.”
Big ocean liners were stuck with massive ships and not much to put on them. Many went bankrupt, and the ones that remained formed alliances.
“Firms started to say, ‘Well, these ships are tremendous investments and there’s too much money on the line,’” said University of Vermont professor Richard Sicotte. “‘Let’s share the capacity among different companies, who would ostensibly be our rivals.’”
Through the 2010s, consolidation accelerated. Eight large carriers, including No. 6 largest ocean carrier Hanjin, either went bankrupt or were acquired by other large firms.
The ‘cartel’ no one noticed?
Crucially, this lack of competition didn’t bother anyone through the 2010s, when ocean rates were absurdly low and carriers were barely turning a profit (if at all). Alliances and consolidation were the only way to make the economics work. Bizarrely, companies continued to build even larger megaships, still chasing those economies of scale while sinking them further into debt.
“Because so few of them were left, they formed these alliances to stop underbidding each other,” Mercogliano said. “The U.S., EU, China, everyone signed off on the idea that these are not cartels. They are not trusts. The reason we did it is because we all benefited from it: We love cheap freight. It cost nothing to move goods across the Pacific.”
That all changed in 2021, when carriers were raking in cash.
The Biden administration called these shipping companies a “cartel.” Some importers have recently claimed that ocean carriers have price gouged them and failed to fill their contracts amid sky-high ocean rates. On the other hand, FreightWaves’ own Greg Miller recently argued that competition among ocean liners increased as rates spiked.
Whether or not these carriers are price fixing is hardly something we can settle in today’s newsletter, but what we can agree on is that this consolidation — driven by the inability of individual companies to fill their own megaships — probably wouldn’t be so stark without those big darn ships.
2. They cause port congestion.
The more obvious reason that big ships are helping cause our ongoing supply chain chaos is that they’re literally too big to fit into most ports. Even the Suez Canal struggled to accommodate one of these megaships, causing the crucial global conduit to be clogged for days last year.
Matt Stoller, who is the director of research at the American Economic Liberties Project, told FreightWaves these megaships are great for moving lots of cargo across oceans. The problem is once you get to your destination. Ocean carriers (and the financial institutions that bankroll them) aren’t paying for updated ports, increased dredging, new warehouses, highways and so on to accommodate these ships. That cost is getting off-loaded to the public, Stoller said.
Indeed, as Mercogliano pointed out, the Port Authority of New York and New Jersey spent a whopping $1.7 billion to raise its Bayonne Bridge to accommodate the shipping scions’ new megaships — a cost that was paid by taxpayers, not ocean carriers or shippers.
One complex is remarkably adept at accommodating those ships: the ports of Long Beach and Los Angeles. As a result, it claims 40% of all U.S. seaborne imports. Before the U.S. saw historic imports in 2020 and onward, this system worked well enough. But over the past year, it’s been remarkably backed up, causing unprecedented supply chain crunches as importers struggled to offload their containers and load empty ones back on to make the trip back to Asia.
If these ships were not so giant, we likely wouldn’t see this kind of congestion. Ocean carriers could bring their normal-sized ships to other ports around the U.S. Stoller pushed for more competition among ocean carriers, which would perhaps mean more diverse types of ships.
“We have a lot of ports in this country but we don’t have enough ocean carrier firms,” Stoller said. “The ocean carrier firms’ boats are too big for most ports.”
3. They’re quietly the reason for the ocean carriers’ financial struggles.
By engaging in the megaships “arms race,” ocean carriers really just played themselves.
One 2016 study by business advisory firm AlixPartners pointed out “the irony of megaships.” In 2016 and 2017, global ocean carrier capacity increased by 4.5% and 5.6%, respectively. But demand only upticked by 1% to 3% those years. The panic to build bigger and bigger ships resulted in depressed rates:
Ironically, says the study, the resulting overcapacity — and corresponding negative effect on profits — is in part the result of the industry’s drive in recent years to correct its chronic supply-and-demand imbalance by building these more efficient but mammoth ships.
Months after that report, the No. 6 largest container shipping company went bankrupt. Hanjin, which had ordered more and more megaships before its insolvency, was in $10.5 billion of debt.
By continually flooding the market with capacity, ocean carriers drove down their own shipping rates. That left them with crushing debt and no way to pay it back. COVID and the influx of trade helped many carriers pay off their massive liabilities, but the good times will eventually run out for these companies.
Praise be! The megaship’s choke hold on our oceans appears to be loosening.
Brilliantly, ocean carriers seem to be reading my mind and hastening the end of the Big Boat Era. Of the thousands of container ships in the pipeline for these next few years, the biggest category is ships ranging from 3,000 to 7,999 TEUs, according to a recent report from Clarkson Research.
As for deliveries scheduled or already made from this year to 2025, 53 are ships with a capacity of 17,000 TEUs or larger, compared to 230 ships with a capacity of 12,000 to 16,999 TEUs.
Perhaps I shouldn’t speak so soon. One 2016 article in the Financial Times, covering a Drewry Shipping Consultants study, claimed that if ships reached 24,000 TEUs, the costs of running such a ship would overtake the profit made from being able to hold so many containers. That would mean losses for the ocean carrier.
And yet, dear reader, shipping magnates have gone ahead with the 24,000-TEU ships: At least a dozen may be sailing as you read this. (Or perhaps, they’re waiting outside of the Port of Long Beach to be unloaded.)
Do you have anything to share about containerized ocean shipping? Email the reporter at rpremack@freightwaves.com, and be sure to subscribe to MODES for your weekly supply chain updates.
May 20, 2022
Giant Container Ship History
Giant container ships are ruining everything
We can blame the Big Boat Era for many of our supply chain headaches
Rachel PremackThursday, May 19, 2022 7 minutes read
Listen to this article 0:00 / 10:53 BeyondWords
I hate big boats, and so should you.
In 2006, Maersk stunned the global shipping community with the introduction of Emma Maersk, a container ship that could carry nearly 15,000 twenty-foot equivalent units. (TEUs translate to about half of a standard forty-foot shipping container.)
Emma Maersk set off an “arms race” with its introduction. Ocean carriers ordered bigger and bigger ships, believing that they could reach economies of scale if they could jam all their shipments into one big boat instead of a few small ones.
Today, we’ve appeared to reach peak Big Boat Era. The Emma Maersk is now wimpy next to 2022’s true megaships. The largest container ships to be delivered this year have a maximum capacity of 24,000 TEUs. (This class of ship is named — I am not making this up — the “Ever Alot.” The Evergreen shipping company, the very same that blocked the Suez Canal last year, ordered the record-breaking ship.)
Each year brings a new, larger-than-ever megaship. The largest ship class of a given year has increased by 50% from 2012 to today, or nearly sixfold from 1981 to today.
Massive container ships have helped wreak serious chaos on global trade. I spoke with four experts this week to learn how megaships are the sneaky reason for much of our ongoing shipping crisis.
Here are the three reasons I hate big boats:
1. They underpin the global shipping oligopoly.
Global shipping is dominated by a few giant firms. But it wasn’t always this way.
In the 1970s, there were so many ocean carriers that no single company controlled the industry. Since then, the market has consolidated into just a few large firms.
Up to 60 of the 100 largest ocean carriers have vanished from the 2000s to today, thanks to a wave of bankruptcies and acquisitions. The top 10 largest ocean carriers in 2000 commanded 51% of the market; today, they dominate 80% of it, according to a White House fact sheet. All of these companies are based outside the U.S.
Smaller ocean carriers began forming alliances with each other in order to compete with larger carriers, said Campbell University professor Sal Mercogliano. Megashippers decided to copy the strategy. Today, the largest ocean carriers are organized into three major container shipping alliances: 2M, The Alliance and Ocean Alliance.
To ship something from, say, China to Los Angeles, you book space on a container ship operated by one of these alliances. Each company shares space on the container ship with other members of the alliance. But these alliances may cancel — or have “blank sailings” — if demand has slumped.
This system has been great for the carriers’ own financial performance. Some claim this consolidation and the alliance system lead to inflated rates.
The Loadstar, a global logistics publication, reported on April 22 that the 2M alliance was blanking at least three Asia-North Europe sailings. New Chinese COVID lockdowns were one reason for the cancellation, but Loadstar also pointed to 2M’s desire to “halt the slide in rates” amid a slump in volume from China. More canceled sailings mean less capacity for cargo, and likely higher rates.
Container ships have been steadily increasing in size since they were created in 1956. But it wasn’t until the 2000s that the Big Boat Era truly began, Mercogliano said. Ocean carriers believed they could reach economies of scale if they built giant ships. The idea was to put all of your cargo on one massive ship instead of two or three smaller ones.
Such megaships were expensive. Emma Maersk, for example, cost an estimated $145 million. But banks were happy to provide the cash, said Capt. John Konrad, CEO of maritime website gCaptain.
Konrad told FreightWaves that ocean carriers are ideal lending targets. If an ocean carrier defaults on its loan, you can simply repossess any of its ships. And, conveniently, many receive hefty subsidies or other support from the governments of the countries they’re based in. Before the financial crisis, banks were happy to provide massive loans to ocean liners to build the megaships of their dreams.
Then 2008 happened. As Mercogliano said, “The freight dried up.”
Big ocean liners were stuck with massive ships and not much to put on them. Many went bankrupt, and the ones that remained formed alliances.
“Firms started to say, ‘Well, these ships are tremendous investments and there’s too much money on the line,’” said University of Vermont professor Richard Sicotte. “‘Let’s share the capacity among different companies, who would ostensibly be our rivals.’”
Through the 2010s, consolidation accelerated. Eight large carriers, including No. 6 largest ocean carrier Hanjin, either went bankrupt or were acquired by other large firms.
The ‘cartel’ no one noticed?
Crucially, this lack of competition didn’t bother anyone through the 2010s, when ocean rates were absurdly low and carriers were barely turning a profit (if at all). Alliances and consolidation were the only way to make the economics work. Bizarrely, companies continued to build even larger megaships, still chasing those economies of scale while sinking them further into debt.
“Because so few of them were left, they formed these alliances to stop underbidding each other,” Mercogliano said. “The U.S., EU, China, everyone signed off on the idea that these are not cartels. They are not trusts. The reason we did it is because we all benefited from it: We love cheap freight. It cost nothing to move goods across the Pacific.”
That all changed in 2021, when carriers were raking in cash.
The Biden administration called these shipping companies a “cartel.” Some importers have recently claimed that ocean carriers have price gouged them and failed to fill their contracts amid sky-high ocean rates. On the other hand, FreightWaves’ own Greg Miller recently argued that competition among ocean liners increased as rates spiked.
Whether or not these carriers are price fixing is hardly something we can settle in today’s newsletter, but what we can agree on is that this consolidation — driven by the inability of individual companies to fill their own megaships — probably wouldn’t be so stark without those big darn ships.
2. They cause port congestion.
The more obvious reason that big ships are helping cause our ongoing supply chain chaos is that they’re literally too big to fit into most ports. Even the Suez Canal struggled to accommodate one of these megaships, causing the crucial global conduit to be clogged for days last year.
Matt Stoller, who is the director of research at the American Economic Liberties Project, told FreightWaves these megaships are great for moving lots of cargo across oceans. The problem is once you get to your destination. Ocean carriers (and the financial institutions that bankroll them) aren’t paying for updated ports, increased dredging, new warehouses, highways and so on to accommodate these ships. That cost is getting off-loaded to the public, Stoller said.
Indeed, as Mercogliano pointed out, the Port Authority of New York and New Jersey spent a whopping $1.7 billion to raise its Bayonne Bridge to accommodate the shipping scions’ new megaships — a cost that was paid by taxpayers, not ocean carriers or shippers.
One complex is remarkably adept at accommodating those ships: the ports of Long Beach and Los Angeles. As a result, it claims 40% of all U.S. seaborne imports. Before the U.S. saw historic imports in 2020 and onward, this system worked well enough. But over the past year, it’s been remarkably backed up, causing unprecedented supply chain crunches as importers struggled to offload their containers and load empty ones back on to make the trip back to Asia.
If these ships were not so giant, we likely wouldn’t see this kind of congestion. Ocean carriers could bring their normal-sized ships to other ports around the U.S. Stoller pushed for more competition among ocean carriers, which would perhaps mean more diverse types of ships.
“We have a lot of ports in this country but we don’t have enough ocean carrier firms,” Stoller said. “The ocean carrier firms’ boats are too big for most ports.”
3. They’re quietly the reason for the ocean carriers’ financial struggles.
By engaging in the megaships “arms race,” ocean carriers really just played themselves.
One 2016 study by business advisory firm AlixPartners pointed out “the irony of megaships.” In 2016 and 2017, global ocean carrier capacity increased by 4.5% and 5.6%, respectively. But demand only upticked by 1% to 3% those years. The panic to build bigger and bigger ships resulted in depressed rates:
Ironically, says the study, the resulting overcapacity — and corresponding negative effect on profits — is in part the result of the industry’s drive in recent years to correct its chronic supply-and-demand imbalance by building these more efficient but mammoth ships.
Months after that report, the No. 6 largest container shipping company went bankrupt. Hanjin, which had ordered more and more megaships before its insolvency, was in $10.5 billion of debt.
By continually flooding the market with capacity, ocean carriers drove down their own shipping rates. That left them with crushing debt and no way to pay it back. COVID and the influx of trade helped many carriers pay off their massive liabilities, but the good times will eventually run out for these companies.
Praise be! The megaship’s choke hold on our oceans appears to be loosening.
Brilliantly, ocean carriers seem to be reading my mind and hastening the end of the Big Boat Era. Of the thousands of container ships in the pipeline for these next few years, the biggest category is ships ranging from 3,000 to 7,999 TEUs, according to a recent report from Clarkson Research.
As for deliveries scheduled or already made from this year to 2025, 53 are ships with a capacity of 17,000 TEUs or larger, compared to 230 ships with a capacity of 12,000 to 16,999 TEUs.
Perhaps I shouldn’t speak so soon. One 2016 article in the Financial Times, covering a Drewry Shipping Consultants study, claimed that if ships reached 24,000 TEUs, the costs of running such a ship would overtake the profit made from being able to hold so many containers. That would mean losses for the ocean carrier.
And yet, dear reader, shipping magnates have gone ahead with the 24,000-TEU ships: At least a dozen may be sailing as you read this. (Or perhaps, they’re waiting outside of the Port of Long Beach to be unloaded.)
Do you have anything to share about containerized ocean shipping? Email the reporter at rpremack@freightwaves.com, and be sure to subscribe to MODES for your weekly supply chain updates.
May 5, 2022
Large Carriers Doing Well for Now
Large truckload carriers say recent downturn not hurting them
‘In the next 4 weeks we will know which theory is correct’
Todd MaidenThursday, May 5, 2022 7 minutes read
Listen to this article 0:00 / 10:49 BeyondWords
While a host of unfavorable freight data points appeared by the end of the first quarter, with trend lines declining further to start the second quarter, many executives at the nation’s largest trucking companies are presenting a much rosier outlook than the data suggests. During the first-quarter earnings season, management teams from publicly traded carriers acknowledged softness in the spot truckload market but said the loosening in capacity won’t likely hurt them.
The growing consensus in the industry is that the little guy is likely in store for pain if spot TL fundamentals have reset lower for the near term. On the other side, well-capitalized, large operators with the majority of their business tied to annual contracts will see a much more manageable environment if the market moderates further.
Just delayed seasonality?
Some industry participants have subscribed to the theory that the recent downturn is just “delayed seasonality” following a prolonged stretch of outperformance, and freight will flow heavily again once China’s lockdowns are lifted.
The new year picked up where 2021 left off with capacity remaining tight and rates continuing to soar. The trend bucked normal seasonality, wherein January and February traditionally see a slowdown in freight demand following the holidays.
March is normally when shipments step materially higher sequentially as consumers exit hibernation, spring merchandise begins to fly off the shelves and produce season nears. March too, didn’t follow normal seasonal trends this year, as demand cooled with each passing day. As industry data points turned sharply lower, investors became spooked and trucking stocks were down by as much as 20% to 40% year-to-date by mid-April.
“I think what is undeniable is that the data is pretty weak and continues to weaken,” Morgan Stanley (NYSE: MS) analyst Ravi Shanker told FreightWaves. He said that it isn’t just trucking data that is soft, some of the firm’s other equity research teams are seeing signs of a downturn as well.
“We know that demand has driven the bulk of the downturn so far and it feels like that is going to get tougher.”
In December, Shanker downgraded his outlook for the freight transportation industry to “cautious” from “in line,” citing the stocks were trading on inflated earnings estimates and valuation multiples after a pronounced bull run. He also flagged a potential “over-inventory” situation as demand was cooling and shippers had ordered merchandise at record levels throughout 2021. His call at the time was that the current trucking cycle would likely end in mid-2022.
While Shanker sees three plausible theories in play now — delayed seasonality, an “air pocket” caused by China lockdowns and the Russian invasion, or the cycle just tapped out one quarter ahead of schedule — it is clear that the industry has hit an inflection point.
“We are still fairly confident that there is going to be a downcycle in the back half of the year. I don’t think it is going to be a massive downcycle,” Shanker said. He expects rates to trough above where they peaked in the last cycle with spot rates seeing the bulk of the reset, not contract rates. Also, the firm’s proprietary TL freight index, which prompted his December downgrade earlier than similar actions from other analysts, has already started to level. Early indications are that the next reading from the dataset is likely to be up slightly.
“In the next four weeks we will know which theory is correct,” Shanker said.
Management commentary positive in Q1, guidance steps higher for some
Commentary from trucking heads thus far in earnings season suggests business as usual at least in the near term. The bifurcation between what’s happening in the spot market versus comments from large carriers about the contract market give the appearance the two aren’t even engaged in the same business.
What has not been surprising is the number of record quarterly performances reported by carriers in the first quarter. The public TLs saw robust freight demand and rates from 2021 spill over into the first three months of the year. For some, revenue and earnings per share were not just first-quarter records but all-time records, a big deal for what is traditionally the seasonally weakest quarter of the year.
Contract rates were well into the double digits last year and early in the 2022 bid season, there has been no letup.
Knight-Swift Transportation’s (NYSE: KNX) formal 2022 guidance calls for TL contract rates to increase by double digits with spot rates continuing to moderate. The company raised full-year EPS guidance to reflect its outperformance in the first quarter. The financial implication is that the outlook for the remainder of the year was unchanged from the initial guide in January.
“As we sit here today, demand for our services, and in particular the asset side of our business, is the strongest I’ve seen in my 27-year career at the company,” J.B. Hunt (NASDAQ: JBHT) Chief Commercial Officer Shelley Simpson stated on a conference call with analysts. The company is hallway through bid season, which Simpson referred to as “the best bid season that I have seen.”
Schneider (NYSE: SNDR) too raised guidance, by 7% at the midpoint of the range, pointing to strength in the contractual market. The company worked through nearly 40% of 2022’s contract renewals in the first quarter and the outcomes were good.
“We are seeing share gain and very healthy improvement in price with recognition towards the inflationary cost around the driver [and] around equipment,” Mark Rourke, CEO and president, stated on a call. “We think the market is still very responsive to that.”
However, to balance the argument, some of the language from management teams has to be taken with the understanding that many companies still have to reprice 60% to 75% of their contractual revenue books and don’t want to show any weakness heading into negotiations.
“Most companies still think that they’re going to have a decent back half,” Shanker said. “I think that’s because they have to.”
The step lower in spot market fundamentals has resulted in many analysts reeling in estimates.
Earnings floor has been raised, higher rates part of the reason
“We do think that the [earnings] floor has been raised,” Shanker said. “I think that’s largely because the cycle floor has been raised.” His assessment comes from the expectation that inflationary pressures will keep spot rates from falling below prior cycle peaks.
It simply costs much more to run a truck now than it did in prior cycles. Lower utilization due to the ELD mandate, along with a notable step up in cost inflation on every expense line, has structurally altered the cost profile. It was the hardening of insurance markets that pushed fleets to fail during the last downturn. Since then, the industry has seen additional capacity move to the sidelines as Drug and Alcohol Clearinghouse compliance has increased.
“All of these supply constraints they’re structural, they’re never going away,” Shanker said. “In fact, Clearinghouse and insurance repeat and reset on Jan. 1 of every year. They’re going to end up taking capacity out of the industry every single year in perpetuity.”
While inflationary headwinds are expected to prop up rates, small carriers will still have a tough time adjusting to their higher cost structures, which include elevated expenses like labor, fuel, insurance, parts, equipment, etc. Also, many of the recently minted entrepreneurs obtained their authority at the peak of the market and also bought their trucks at the peak of the market. The reality of a downturn will be tough to overcome for a group that may have modeled its new venture off of all-time high spot rates.
More diversity in the model but the cycle is largely the same
Some carriers have diversified their offering, branching out into intermodal, brokerage and other asset-light offerings. The changes have smoothed out some of the booms and busts historically seen in asset-based TL. These efforts accelerated further during the pandemic as record free cash flow generation allowed for a bigger push in M&A and other organic initiatives.
Spreading out the business has some management teams suggesting their models are now better built to weather a downturn, meaning earnings are unlikely to revert back to prior trough levels.
“I think the diversification helps reduce the cyclicality of earnings,” Shanker said. “[TL earnings] have a lot more upside in the upcycle and more downside in the downcycle. That range of cyclicality kind of narrows with every level removed you are from TL.
“At the end of the day, if you’re in this industry and you have a TL, LTL, intermodal, logistics business, it’s all the same cycle. It might be one is early cycle, one is mid cycle, one is late cycle, and the difference is a matter of quarters, not years.”
No material relief for shippers in 2022
Shanker noted in a report last week that lower rates in the spot market wouldn’t provide any material rate relief to retail shippers this year as the bulk of their freight is tied to contracts. Contractual rates lag changes in spot rates by several months in most cycles, meaning it’s likely 2023 before most shippers see relief.
However, shippers could see some relief on all-in freight costs. Freight costs surged in the second half of 2021 as record consumer demand had many supply chain managers scrambling to pace inventories with sales. That pushed shippers to use more expensive airfreight options versus ocean. Once the merchandise landed in the U.S., they were forced to use a higher-cost spot market for capacity more than they would have liked.
The thought is total freight costs could net out lower as shippers move away from the premium options used last year. Also, any pick up in supply chain fluidity would likely lower costs as well. However, the report said if shippers were to see material cost relief in 2022, it’s likely due to consumer demand rolling over or it turns out they over ordered merchandise trying to navigate supply chain bottlenecks.
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