AIRFREIGHT & SURFACE TRANSPORTATION. Preview. In-Depth Update, Industry Primer, and Truck Carrier Survey

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1 AIRFREIGHT & SURFACE TRANSPORTATION THE WHOLE TRUCKING STORY Airfreight & Logistics Market Underweight Railroads Market Weight Trucking Market Underweight May 2009 THE WHOLE TRUCKING STORY In-Depth Update, Industry Primer, and Truck Carrier Survey Truck Stocks Holding Up Relatively Well. During the past 15 months, the S&P 500 is down 36%, but our Truck Index has declined just 18% despite exceptionally weak demand that has caused overcapacity to surge, utilization and pricing to plunge, and revenue and earnings trends to weaken. Why is this? We would point to truck short deleveraging (i.e., forced buying), quickly declining diesel prices with a lagging surcharge benefit, and investors belief that truck stocks, as early-cyclicals, will eventually lead a turn in the market. Cyclical and Secular Peak for Valuation? While Truckload (TL) stocks have generally led in and out of downturns over the past 20-plus years, those downturns have typically been consumer-driven. The current downturn was originally led down by housing and the credit markets, but the recent stepdown reflects reduced manufacturing and commodity demand and thus Less-than-Truckload (LTL) sector and Rail volumes. We expect the consumer to lag manufacturing as unemployment increases and demand stabilizes at historically low levels, with risk of further declines. Thus, we view current Truck cyclical peak valuations, which discount 2009 trough earnings, as stretched, since we expect issues involving utilization and pricing to trail demand during the downturn and eventual gradual recovery. On a secular basis, our view is that public TL carriers, which have gone from taking market share to ceding it over the past decade, should no longer trade at a premium to the S&P 500. What s in This Report? This report sets out our current negative view on the Truck sector, explains where we are in the cycle relative to historical cycles and valuations, and offers indicators to watch for to become more positive on the group. We also provide background on the distinctions, size, and history of the Truckload, Less-than-Truckload, and Intermodal markets, in addition to charted responses to our recent surveys of truck carriers regarding their expectations for truck orders and new engine technologies. We conclude with short reports on each public trucking company we cover and a glossary of truck industry terms. Edward M. Wolfe (646) ewolfe@wolferesearch.com Timothy J. Denoyer (646) tdenoyer@wolferesearch.com Michael A. Addeo (646) maddeo@wolferesearch.com This report is limited for use solely by clients of Wolfe Research, LLC. Please refer to the end of this report for restrictions, legal disclosures and analyst certifications.

2 Table of Contents TABLE OF CONTENTS...2 EXECUTIVE SUMMARY...7 Early-Cyclical Call Feels Premature...7 We Expect Truck Pricing to Lag Weakened Demand...7 Surprisingly, Truck Supply Has Not Tightened as Much as Last Downturn...8 Consensus Expectations Remain Materially Overly Optimistic...9 When Should Investors Look to Invest in Trucks Again?...10 IN THIS REPORT...11 INVESTMENT CONCLUSION...14 OUR VIEW ON TRUCKING REMAINS NEGATIVE...14 PEAK AND TROUGH P/E ANALYSIS...15 LTL STOCKS CLOSER TO BOTTOM...15 YRC WORLDWIDE S SURVIVAL PRESSURES REMAINING LTL STOCKS...16 MACRO ANALYSIS...18 TRUCKING IS EARLY-CYCLICAL...18 Truck Stocks Have Bottomed Before Truck Demand in Recent Downturns...19 WE EXPECT AN EXTENDED DEMAND DOWNTURN...23 Truck Tonnage Could Weaken Further Since It Is Not Yet as Weak as Past Cycles...24 TRUCK TONNAGE NOT YET AS WEAK AS RAIL TONNAGE...27 Relationship Among GDP, Tonnage, and Share Prices...28 Inventory/Sales Ratio...29 Revenue, Operating Ratios, and EBIT...32 THE FED IS A KEY DRIVER OF TRUCK STOCKS...35 Truck Stocks and Fed Easing Cycles...36 Truck Stocks and Fed Tightening Cycles...39 TRUCKING BACKGROUND FOR TL, LTL, LEASING, AND INTERMODAL MARKET...41 SIZE OF U.S. TRUCK MARKET...41 DIFFERENTIATING BETWEEN TL AND LTL...42 BREAKDOWN OF U.S. TRUCK FLEET BY SIZE...46 TRUCK LEASING...46 Stronger Regional Demand Trends Changing Trucking Business Model...47 LTL CHARACTERISTICS...48 TL SERVICES...48 TRUCKING INDUSTRY REGULATION...50 EPA Emissions Regulations to Shape Investment Cycles and Productivity for Years to Come...52 HOS Could Be Shortened Under New Administration...54 Obama s Support for Employee Free Choice Act Could Put Non-Union Companies at Risk...57 Potential Legislation for Heavier Trucks...58 Could Southern California Port Regulations Lead to Broader Increased Regulation of Trucking?...58 California Air Resources Board Also Pushing for Accelerated Clean Truck Adoption...60 Carbon Cap and Trade System Possible upon Recovery...61 Cross-Border Trucking Program Shut Down Quickly Under New Administration, Causing Minor Trade Spat...61 Page 2

3 PENSION RISKS FOR TRUCKING...63 ONGOING PROBLEM...63 BACKGROUND ON UNION LTL CARRIERS MULTI-EMPLOYER PENSION EXPOSURE...64 PPA Brings Underfunded Pensions into Focus...64 Implementation of PPA Leading to Higher Contributions and Benefit Cuts...65 A TIMELINE FOR THE TRUCKING INDUSTRY...67 TL EXECUTIVE SUMMARY...73 REASONS TO INVEST IN TL...73 When Demand Improves, Recovery Could Be Strong...73 RISKS TO INVESTMENT IN TL...74 TL VALUATION...76 Public TL Returns on Capital Best Among Asset-Based Transports...76 HISTORICAL FORWARD P/E ANALYSIS...78 HISTORICAL FORWARD EV/EBITDA ANALYSIS...79 TRAILING FORWARD P/E ANALYSIS...80 HISTORICAL TRAILING EV/EBITDA ANALYSIS...81 HISTORICAL TRAILING PRICE/BOOK ANALYSIS...82 Current Target Prices/Fair Values...83 CURRENT TL VALUATION RELATIVE TO EACH TL CARRIER S HISTORICAL AVERAGE...83 CURRENT TL VALUATION RELATIVE TO HISTORICAL PEAK AND TROUGHS...84 TL VOLUME ANALYSIS...86 THE TL CYCLE SHOULD FIND A BOTTOM... EVENTUALLY...86 TL PRICING/FUEL...88 TRUCKLOAD CONTRACTUAL PRICING DECLINING AGAIN...88 FUEL AFFECTS TRUCKING IN A VARIETY OF IMPORTANT WAYS...90 The Most Volatile and Variable Cost Issue TL Companies Face...90 HIGHER DIESEL COSTS SPUR INTERMODAL...92 LOWER FUEL PRICES KEEPING MARGINAL TRUCKERS IN THE MARKET...94 STOCK PERFORMANCE HIGHLY CORRELATED TO DIESEL PRICES...94 TL CAPACITY...96 HIGHLY FRAGMENTED INDUSTRY...96 SMALL FLEETS DOMINATE THE MARKET...96 WORKING OFF EXCESS TRUCKS FROM PRE-BUY...97 TRUCK VERSUS RAIL SECULAR TRENDS FAVOR RAIL OVER TRUCK FUEL PRICE SPIKE STILL AFFECTING NEAR-TERM INTERMODAL TRENDS PRICING GAP BETWEEN RAILS AND TRUCK TRUCK PRICING RELATIVE TO TRUCK AND RAIL EQUIPMENT BUILDS LTL EXECUTIVE SUMMARY MOST COMPETITIVE LTL MARKET POSSIBLY EVER LTL MARKET LOSING SHARE ON A SECULAR BASIS HOWEVER, IN A DOWNTURN, LTL CAN TAKE SHARE NON-UNION SHARE GAINS LIKELY TO CONTINUE FURTHER INDUSTRY CONSOLIDATION LIKELY LTL VALUATION LOW-END RETURNS FOR LTL SECTOR Page 3

4 LOW-END GROWTH FOR LTL SECTOR HISTORICAL LTL FORWARD P/E VALUATIONS LTL HISTORICAL PEAK/TROUGH P/E LTL PRICE TO TRAILING BOOK VALUE LTL FORWARD EV/EBITDA LTL TRAILING P/E AND EV/EBITDA VALUATION LTL VOLUME ANALYSIS LTL Tonnage Likely Close to Bottoming, But at Historically Weak Levels LTL PRICING/FUEL ANALYSIS Weak Pricing Could Depress LTL ORs and Earnings into FUEL AFFECTS LTL IN A VARIETY OF SIGNIFICANT WAYS Year-over-Year Declines in Fuel Prices Hurt LTL Recent Stock Performance Highly Correlated to Diesel Prices LTL Fuel Surcharge Class-Action Lawsuit Recently Dismissed LTL OPERATING LEVERAGE AND RETURN ON CAPITAL STRONG OPERATING LEVERAGE TO AN IMPROVING ECONOMY Union LTLs Face Worsening Labor Cost Disadvantage from Pensions RECENT LTL WAGE REDUCTIONS RISING UNION BENEFIT COSTS PENSION COSTS LIKELY TO RISE FOR SEVERAL LTL OPERATORS LTL BANKRUPTCY CASE STUDY CONSOLIDATED FREIGHTWAYS (SEPTEMBER 3, 2002) SURVEY RESULTS SUMMARY OF KEY FINDINGS BUSINESS AND CUSTOMER MIX USED TRUCK MARKET FUEL ISSUES COST SAVINGS INITIATIVES TRACTOR/TRAILER REPLACEMENT CYCLES CAPITAL EXPENDITURES FLEET PLANNING AND EPA REGULATIONS IMPLICATIONS OF NEW EGR ENGINES ARKANSAS BEST (ABFS $22.03 UNDERPERFORM) INVESTMENT CONCLUSION We Rate Arkansas Best Shares Underperform COMPANY BACKGROUND Management Customers and Segmentation ADDITIONAL KEY POINTS POTENTIAL POSITIVES FOR ARKANSAS BEST S STOCK CELADON GROUP, INC. (CLDN $7.09 UNDERPERFORM) INVESTMENT CONCLUSION We Rate Celadon Shares Underperform COMPANY BACKGROUND Management Customers and Segmentation ADDITIONAL KEY POINTS INVESTMENT POSITIVES Page 4

5 CON-WAY (CNW $22.58 UNDERPERFORM) Our Underperform Rating Is Unchanged INVESTMENT CONCLUSION COMPANY BACKGROUND Management KEY POINTS EXPANDED POTENTIAL POSITIVES FOR CON-WAY S STOCK HEARTLAND EXPRESS, INC. (HTLD $15.17 UNDERPERFORM) We Rate Heartland Underperform INVESTMENT CONCLUSION COMPANY BACKGROUND Management KEY POINTS EXPANDED INVESTMENT POSITIVES J.B. HUNT TRANSPORT SERVICES (JBHT $27.99 UNDERPERFORM) INVESTMENT CONCLUSION We Rate J.B. Hunt Underperform COMPANY BACKGROUND Management Customers and Segmentation KEY POINTS EXPANDED INVESTMENT POSITIVES KNIGHT TRANSPORTATION (KNX $17.54 UNDERPERFORM) INVESTMENT CONCLUSION We Rate Knight Underperform COMPANY BACKGROUND Management Customers and Segmentation KEY POINTS EXPANDED INVESTMENT POSITIVES OLD DOMINION FREIGHT LINES, INC. (ODFL $28.27 UNDERPERFORM) INVESTMENT CONCLUSION We Rate Old Dominion Underperform COMPANY BACKGROUND Management Acquisitions Customers and Segmentation KEY POINTS EXPANDED INVESTMENT POSITIVES RYDER SYSTEM (R $26.89 UNDERPERFORM) INVESTMENT CONCLUSION We Rate Ryder Underperform COMPANY BACKGROUND Management Customers and Segmentation KEY POINTS EXPANDED INVESTMENT POSITIVES SAIA, INC. (SAIA $12.56 UNDERPERFORM) INVESTMENT CONCLUSION Page 5

6 We Rate Saia Underperform COMPANY BACKGROUND Management KEY POINTS EXPANDED INVESTMENT POSITIVES WERNER ENTERPRISES, INC. (WERN $16.30 UNDERPERFORM) INVESTMENT CONCLUSION We Rate Werner Underperform COMPANY BACKGROUND Management Customers and Segmentation KEY POINTS EXPANDED INVESTMENT POSITIVES YRC WORLDWIDE INC. (YRCW $3.24 PEER PERFORM) INVESTMENT CONCLUSION We Rate YRC Worldwide Peer Perform COMPANY BACKGROUND Management KEY POINTS EXPANDED INVESTMENT POSITIVES GLOSSARY OF TRUCK TERMS Special thanks to David Mele, Rob Farley and Matt DeRosa for their contributions to this report. All pricing is as of the market close on April 24, 2009 unless otherwise indicated Page 6

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8 IMPORTANT DISCLOSURES Contact Wolfe Research, LLC at for rating and price target history, valuation methodology, and risks to our target prices for covered companies. Securities in this report priced as of the close of business on 4/24/2009. Wolfe Research, LLC Stock Ratings Key: Outperform (OP): The security is projected to outperform analyst's industry coverage universe over the next 12 months. Peer Perform (PP): The security is projected to perform approximately in line with analyst's industry coverage universe over the next 12 months. Underperform (UP): The security is projected to underperform analyst's industry coverage universe over the next 12 months. Wolfe Research, LLC Sector Weighting System: Market Overweight (MO): Expect the industry to outperform the primary market index for the region (S&P 500 in the U.S.) by at least 10% over the next 12 months. Market Weight (MW): Expect the industry to perform approximately in line with the primary market index for the region (S&P 500 in the U.S.) over the next 12 months. Market Underweight (MU): Expect the industry to underperform the primary market index for the region (S&P 500 in the U.S.) by at least 10% over the next 12 months. Wolfe Research, LLC Distribution of Investment Ratings (As of April 24, 2009): Outperform: 20.0% 0% Investment Banking Clients Peer Perform: 30.0% 0% Investment Banking Clients Underperform: 50.0% 0% Investment Banking Clients Wolfe Research, LLC Research Disclosures: Company Disclosure Company Disclosure Arkansas Best Corp. (ABFS) None Kansas City Southern (KSU) None Burlington Northern Santa Fe (BNI) None Knight Transportation (KNX) None C.H. Robinson (CHRW) None Landstar System (LSTR) None Canadian National (CNI) None Norfolk Southern Corp. (NSC) None Canadian Pacific (CP) None Old Dominion (ODFL) None Celadon (CLDN) None Pacer International (PACR) None Con-way Inc. (CNW) None Ryder System Inc. (R) None CSX Corp. (CSX) None Saia, Inc. (SAIA) None Expeditors International (EXPD) None TNT N.V. (TNTTY) None FedEx Corp. (FDX) None Union Pacific (UNP) None Forward Air (FWRD) None United Parcel Service (UPS) None Genesee and Wyoming (GWR) None Universal Truckload (UACL) None Heartland Express (HTLD) None UTi Worldwide (UTIW) None Hub Group (HUBG) None Werner Enterprises (WERN) None J.B. Hunt Transport (JBHT) None YRC Worldwide Inc. (YRCW) None Page 341

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