A Smoother Road for Less-Than-Truckload?

The recent freight recession decimated the profitability of most less-than-truckload (LTL) carriers, primarily because the industry is marked by asset intensity and minimal switching costs--factors that drive our no-moat ratings for all pure-play LTL stocks in our coverage universe. Profitability is thus quite cyclical with limited protection from the competitive landscape, particularly during periods of weak freight demand. Consequently, throughout 2009 as freight volume tumbled, numerous struggling carriers on the brink of collapse slashed rates to unsustainable levels in a desperate attempt to grab volume and stay afloat. Nonetheless, industry pricing (yield) reached a key inflection point in the latter half of 2010 as capacity utilization improved. Since then, carriers' yield gains have largely continued. Although year-over-year growth comparisons become a bit more difficult in the second half of 2011, we expect favorable pricing conditions to remain a tailwind. In fact, pricing execution has become the focal point for most LTL carriers as they endeavor to recapture normal operating margins.

The chart below depicts LTL industry yield trends over the past few years. Excluding the recent, rapid rise in fuel surcharges, we estimate base rates increased 3%-4% year over year on average in fourth quarter 2010 and first quarter 2011. In general, recovering freight demand and the return of rational rate setting among the industry leaders have supported the pricing improvement. More specifically, rising volume has consumed excess capacity, enabling carriers to launch aggressive initiatives aimed at shoring up historically low yields. These efforts have been particularly focused on underpriced contractual business, and negotiations have met with success.  Con-way (CNW),  Arkansas Best (ABFS), and  Old Dominion (ODFL), for example, all generated mid-single-digit rate increases on average in first-quarter contract negotiations. Moreover, most of the major LTL carriers implemented two general rate increases (each around 6%) during 2010. Encouragingly, a significant portion of these GRIs appears to be sticking.