2017 US Economic & Transportation Outlook A Look At Structural Changes To Logistics

Transcription

1 Industrial Research February 23, US Economic & Transportation Outlook A Look At Structural Changes To Logistics If you would like to be added to our monthly research distribution list, which we make freely available, please me at bhartford@rwbaird.com Benjamin J. Hartford, Senior Research Analyst bhartford@rwbaird.com Please refer to Appendix Important Disclosures and Analyst Certification

2 A Look Back at 2016 Positives: Avoided US recession during 1H16 Recovery in commodity prices and industrial activity (both US and globally) Post-election, rebound in business and consumer confidence amid anticipated tax/regulatory reforms Negatives Still a mature economic cycle, with risks Strengthening US dollar Elevated leverage Increased trade protectionism will rhetoric turn to action? 2

3 A Look Ahead to 2017 and Beyond Economic cycle dynamics aside, transportation markets are at a confluence of events that can produce a tremendous amount of change. Structural changes in society, including shifts in demographics, changing attitudes and behaviors including openness to trade Technological evolution enabling new modes (B2C) and new capabilities (Logistics 2.0); impacts on logistics still in their early stage. Amazon at the forefront of the e-commerce revolution 3

4 A Look Back at

5 A Look Back at 2016 Equity (stock) markets recovered from the early 2016 recession scare and both stocks and bond yields rose rapidly following the November election. 2, % Performance (Absolute) 2,300 2,200 2,100 2,000 1, % 2.5% 2.0% 1.5% 1.0% Yield (%) 1, % Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 S&P yr US Treasury Yield Source: FactSet 5

6 A Look Back at 2016 Similarly, crude oil prices (and commodities broadly) recovered from their early-2016 lows, spurring recovery in US industrial end-market activity. 55 $57 PMI $49 $41 $33 WTI Crude ($/mmbtu) 47 $25 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 U.S. ISM PMI WTI Crude Oil Note: PMI (Purchasing Managers' Index) is an indicator of the economic health of the manufacturing sector, based on surveys sent to purchasing executives. Source: FactSet, ISM 6

7 We Avoided Recession in 2016 This cycle s peak-to-trough drawdown was shallower than any formally defined US recession since Industrial Production, SA (Jan 2007 = 100) US Industrial Production Drawdowns US Industrial Production, SA Drawdowns (Peak to Trough) 1. US IP (Feb Jul 1980): -6.5% 4. US IP (Jun Nov 2001): -5.9% 2. US IP (Jul Dec 1982): -9.2% 5. US IP (Dec Jun 2009): -16.9% 3. US IP (Sep Mar 1991): -4.2% 6. US IP (Feb Mar 2016): -3.7% Source: Federal Reserve 7

8 We Avoided Recession in 2016 Similarly, the past two US recessions have been marked by negative retail inventory growth and ISM Inventories readings below 40. Neither have occurred this cycle. 20% 60 Growth (%, yoy) 15% 10% 5% 0% -5% -10% ISM Inventories -15% Recession Retail Inventory Growth, YoY ISM Inventories Source: ISM, NBER, U.S. Census Bureau, Baird estimates 8

9 Decomposing the Trump Bump 9

10 The Market Broadly Rallied Post- Election Strong US equity and currency (US dollar) performance post-election purely a function of the election s result, or is there more to it? 2016 Performance Across US Equities 2016 Performance of the US Dollar % 2.50% 2.25% 2.00% 1.75% 1.50% 1.25% % Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 S&P 500 Dow Jones Industrial Average Dow Jones Transportation Average Jan-2016 Feb-2016 Mar-2016 Apr-2016 May-2016 Jun-2016 Jul-2016 Aug-2016 Sep-2016 Oct-2016 Nov-2016 Dec-2016 Jan-2017 Feb-2017 ICE US Dollar Index US 10-Year Treasury Yield (%) Source: FactSet 10

11 Given 1) Optimism Surrounding Policy Reform A number of items in the Trump administration s 100-day plan are viewed positive for US economic growth: Reduction in corporate tax rates Cash repatriation tax cut (one time reduction in taxes paid on foreignly-held currency brought back to the US) Infrastructure initiatives Accelerated depreciation of capex Regulatory changes 11

12 And 2) Increased Confidence Among Businesses and Consumers While much of the post-election rally discounted expectations of stronger future growth, rising confidence carries direct implications to freight. Consumer Confidence Index Small Business Optimism Index US Recession Consumer Confidence Index Small Business Optimism Index, 3-mo. MA (Right Axis) Source: The Conference Board, NBER, NFIB 12

13 ...Which Bodes Well for Economic Activity Rising consumer confidence tends to lead spending, and could support spending growth acceleration positive for freight growth % 130 8% Consumer Confidence Index % 4% 2% 0% Growth (%, yoy) 30-2% 10-4% US Recession Personal Consumption Expenditure Growth (R) Consumer Confidence (L) Disposable Personal Income Growth (R) Source: Blue Chip Economic Indicators, BEA, NBER, The Conference Board 13

14 ...Which Bodes Well for Economic Activity Similarly, small business optimism (which can lead to hiring, capex, etc.) tends to correlate with US GDP growth so the higher the level of confidence, the better. Index % 9% 6% 3% 0% -3% Growth (%, yoy) 80-6% US Recession Small Business Optimism Index, 3-mo. MA Real GDP Growth (%, yoy) Source: BEA, NBER, NFIB 14

15 However, Fundamentals Were Already Improving Prior to the US Election Cyclical improvement was already underway prior to the November election, both in the US and globally PMI Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 JPM Global Manufacturing PMI Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 U.S. ISM PMI Jan-17 Source: ISM 15

16 Now, for Some of the Negative Developments in

17 This Cycle Is Long in the Tooth Length of economic expansions and recessions Cumulative real GDP by cycle, peak to peak Q48-2Q53 2Q53-3Q Contraction: 15 months Expansion: 46 months 150 3Q57-2Q60 4Q69-4Q73 2Q60-4Q69 4Q73-1Q Q80-3Q81 3Q81-3Q Q90-1Q01 1Q01-4Q Q07 - Pres June 1897 (II) December 1900 (IV) August 1904 (III) June 1908 (II) January 1912 (IV) December 1914 (IV) March 1919 (I) July 1921 (III) July 1924 (III) November 1927 (IV) March 1933 (I) June 1938 (II) October 1945 (IV) October 1949 (IV) May 1954 (II) April 1958 (II) February 1961 (I) November 1970 (IV) March 1975 (I) July 1980 (III) November 1982 (IV) March 1991(I) November 2001 (IV) June 2009 (II) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Source: BEA, NBER 17

18 Primary Headwind to Transports: USD Strength... The recent breakout of the US dollar should be closely watched This USD strength in 2H14 ICE US Dollar Index Source: FactSet Jan-2017 Oct-2016 Jul-2016 Apr-2016 Jan-2016 Oct Jul Apr Jan ICE US Dollar Index 18

19 ...Pressures US Industrial Activity led to this US ISM PMI and IP weakness during % 60 ICE U.S. Dollar Index Growth (%, yoy) (Inverse) -10% 0% 10% 20% 30% PMI US Dollar Price Growth (%, yoy) U.S. ISM PMI Source: FactSet, Federal Reserve, ISM 19

20 Two Other Negatives from 2016 Debt levels remain elevated across the globe. Grey bars indicate US recessions; sovereign debt levels have risen steadily throughout this recovery. 250 Central Government Debt (% of GDP) Canada France Italy USA Germany UK Japan Source: OECD 20

21 Two Other Negatives from 2016 Trade protectionism (government restrictions on trade) is on the rise. Source: International Monetary Fund, Wall Street Journal 21

22 A Look Ahead to 2017 and Beyond 22

23 Truckload Industry Pricing Growth Should Improve from 2016 s Decline helped by healthier spot demand in late 4Q16/early 1Q17 than prior years Jan Feb Mar Apr Demand Index May Jun Jul Aug Sep Oct Nov Dec Source: Industry data, Baird estimates 23

24 Truckload Industry Pricing Growth Should Improve from 2016 s Decline Note the drawdown in truckload capacity this cycle has mimicked the drawdowns of the prior two cycles, which we believe backstops pricing growth. 100% 80% Above (Below) Average (%) 60% 40% 20% 0% -20% -40% -60% -80% Recession Class 8 Build (12-mo MA/75-mo MA) Class 8 Net Orders (12-mo MA/75-mo MA) Source: ACT Research, FactSet, NBER, Baird estimates 24

25 Truckload Industry Pricing Growth Should Improve from 2016 s Decline An inflection in TL pricing growth in 2017 should support broader modes. 10% 8% 6% Pricing Growth (yoy) 4% 2% 0% -2% -4% -6% -8% LTL Pricing IM Pricing TL Pricing Railroad Pricing Source: FactSet, Baird estimates 25

26 Structural Changes in Society: Implications for Logistics 26

27 Structural Changes in Society Drive Changes in Long-Term Trends Characteristics in generations are shaped by their experience; these shifts in younger generations will influence supply chains in the years to come. Source: Insight Magazine, US Department of Labor, FDU Magazine, Talentor 27

28 Other Structural Changes with Significant Implications for Transports Attitudes shift over time and not necessarily in a favorable direction. Source: The New York Times 28

29 Other Structural Changes with Significant Implications for Transports Which is why the recent shift in attitudes regarding free trade matter. Source: Heritage Foundation, Pew Research Center 29

30 Other Structural Changes with Significant Implications for Transports Trade openness measured below by calculating trade (imports and exports) as a percentage of GDP has peaked, which is concerning for global trade volumes specifically. Source: OECD, World Bank, Baird estimates 30

31 Other Structural Changes with Significant Implications for Transports Recent political rhetoric surrounding trade has undoubtedly turned protectionistic. Increased tariffs (import/export taxes), specifically, would further reduce trade s openness. Source: Fathom Consulting, Thomson Reuters Datastream 31

32 Other Structural Changes with Significant Implications for Transports The topping of trade openness has also contributed in part to slower industry volume growth rates across modes. 12% 10% 9.6% 8% CAGR (%) 6% 4% 4.4% 3.5% 5.5% 3.3% 5.8% 2.9% 2.8% 2% 0% 1.3% 1.3% 0.4% 0.4% TL LTL* AF OF US GDP US IP Source: ATA, BEA, Federal Reserve, IATA, Industry data, Baird estimates *LTL data begins in

33 Other Structural Changes with Significant Implications for Transports More broadly, declines in the openness to trade are troubling, not the least of which because trade has been very good for humanity. Source: Our World in Data 33

34 Other Structural Changes with Significant Implications for Transports Clearly, income inequality has contributed to the current political climate Source: The Economist 34

35 Other Structural Changes with Significant Implications for Transports But the distribution of the expansion of trade over the past 30 years has been unequal. Lower/middle classes of developed markets/countries have generally not participated Source: Branko Milanovic, Heyman Center, World Bank, hbr.org 35

36 Other Structural Changes with Significant Implications for Transports and clearly participation in growth drives attitudes toward trade openness and globalization Source: The Economist, YouGov, World Bank, UN 36

37 Other Structural Changes with Significant Implications for Transports which suggests protectionism is likely to rise, not fall, during given upcoming elections in developed markets. Source: The Wall Street Journal 37

38 Technology & E-Commerce: Still Very Early in Its Impact on Logistics 38

39 Scope & Pace of Genuinely Disruptive Technologies Often Difficult To Grasp Source: Tony Seba, US National Archives 39

40 Scope & Pace of Genuinely Disruptive Technologies Often Difficult To Grasp Source: Tony Seba, George Grantham Bain Collection 40

41 E-Commerce Fits the Definition of a Genuinely Disruptive Change Advantages of e-commerce retailers over traditional retailers: Pull system of inventory management (products enter the supply chain when customer demand justifies it): Limited inventory (at the early stages) Improved free cash flow (negative operating cycle) Greater personalization of customer experience Broader selection of merchandise at more convenient access to customers Reduced prices And don t dismiss the impact from people s natural resistance to change, particularly among incumbents 41

42 E-Commerce Fits The Definition of a Genuinely Disruptive Change The dominant driver of disruption stems from a transition from a push focus in retail (projected demand drives the supply chain) to one of a pull focus. Working capital needs fall (lower inventory carrying costs, improved cycle times and limited physical infrastructure needs), freeing capital to focus on maximizing consumer satisfaction. Source: Digital Marketing Xperts, Baird 42

43 E-Commerce Causing Disruptive Changes To Supply Chain Design, Too Push System Pull System Source: Jones Lang LaSalle 43

44 E-Commerce Reduces Inventory Working Capital but Only at the Early Stages Retail Inventory/sales, 12 mo-ma 1.8x 1.7x 1.6x 1.5x 1.4x Recent rise driven by B2C s increased influence, in our view. 1.3x Retail Inventories/Sales (left axis) Source: U.S. Census Bureau 44

45 Amazon Has Been at the Forefront of the E-Commerce Revolution Two points: 1) B2C is still in the early stages and impossible to facilitate without technology 60k 45% 12% Millions of USD 50k 40k 30k 20k 10k 0k Growth (%, yoy) 35% 25% 15% 5% -5% -15% 10% 8% 6% 4% 2% 0% E-Commerce as a % of Retail Sales Recession Retail Trade: Department Stores, SA Retail Trade: Nonstore Retailers, SA E 2017E 2018E 2019E 2020E Retail Sales (L) E-commerce (L) E-Commerce as a % of Total Retail Sales (R) 2) 43% of all online retail sales in the US went through AMZN in 2016 Source: BEA, emarketer, Forester Research, US Census Bureau, Business Insider, Slice Intelligence, Baird estimates 45

46 To Digest Such Massive Growth, AMZN s Focus Remains Managing Fulfillment Key logistics-related initiatives by AMZN since its 2013 Dragon Boat plan: 2013 November: begins working with USPS for package delivery on Sunday and holidays December: AMZN founder Jeff Bezos states a drone delivery program was four, five years away from being viable 2016 January: reports of Amazon China receiving an NVOCC license March: Amazon Fulfillment Services reaches agreement for ATSG to operate 20 leased Boeing 767 freighter aircrafts December: Bezos releases a video of AMZN s first-ever Prime Air drone delivery December: reports that AMZN is building an Uber for trucking app, scheduled to launch mid January: reports AMZN began offering freight forwarding services to Chinese merchants using its NVOCC January: CVG officials announce AMZN will build a $1.5 bln Prime Air hub Source: WSJ, CBS, AMZN, ATSG 46

47 To Digest Such Massive Growth, AMZN s Focus Remains Managing Fulfillment Four principal risks facing incumbent logistics providers, in our view: AZMN s ongoing share gain from traditional retailers (i.e., incumbent logistics providers customers) Further vertical integration of logistics services Offering learned/developed logistics capabilities in a thirdparty capacity Denial & natural resistance to change 47

48 Other Disruptive Changes on the Horizon Enabled by Technology Other disruptive changes on the horizon enabled by technology: Greater supply chain transparency opportunity for cost savings for shippers and share gains among scaled logistics providers A recent SMC3 survey asked 60 participants in what areas are you seeing the greatest demand from your customers? Roughly 60% responded greater visibility Another 23% responded lower costs 10% stated greater collaboration Only 5% responded need for speed Automation of networks another source of share gains among scaled logistics providers and a rethink of supply chain design Source: SMC3 48

49 Where Do We Go from Here? A couple quick conclusions: 1. The volume outlook is unclear, but the future s inherently uncertain. On one hand, US policy reform and broader reflation could lead to healthier economic activity next cycle; That said, we appear to remain in the latter stages of this cycle s recovery; and increased trade protectionism creates material volume (and geopolitical) risk in upcoming years. 2. Longer term, the transportation/logistics industry is ripe for change nearly 40 years beyond industry deregulation. Changing demographics lead to new attitudes as to how to conduct business; Continued evolution of technology leads to 1) the creation of new services and 2) greater efficiency in executing old ones. 49

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